before the wyoming public service commissionpsc.state.wy.us/oca/cases/mdu 14409/14409 bryce freeman...
TRANSCRIPT
OCA Exhibit 201
BEFORE THE WYOMING PUBLIC SERVICE COMMISSION
IN THE MATTER OF THE APPLICATION ) OF MONTANA-DAKOTA UTILITIES CO. ) FOR A GENERAL RATE INCREASE IN ) ITS WYOMING ELECTRIC UTILITY ) SERVICE)RATES OF $3 ,225,447 PER ) ANNUM )
DIRECT TESTIMONY OF
Bryce J. Freeman
Docket No. 20004-117-ER-16 (Record No. 14409)
On behalf of the Wyoming Office of Consumer Advocate
Filed October 13, 2016 Hearing January 18, 201 7
OCA Exhibit 20 I
Table of Contents
INTRODUCTION AND QUALIFICATIONS .......... .............. ............ .. ....... .... ..... .. .......... ...... ......................... ........ 2
PURPOSE .... ....... ....... ... ............. ........ ........ ........ ......... ..... ........... ... ............ ........................... .. .......... .. ....... ...... 5
COST OF CAPITAL- BACKGROUND ... .... ................ .. ... ...... ......... ..... .. ........ ..................................................... 7
MARKET RISK DYNAMICS ... ..................... ...... .. ....... ..... ....... ... ........ ........ ................ .. ..... ..... .. .... ..... ............... 10
BUSINESS RISK ..... .. ... ............... ... .... ....... ...................................................................................................... 17
COMPARABLE COMPANIES ............ ....... ........ ..... .... .. ............. ..... ................................. ... ....... ...... .. ........ ...... 23
CONSTANT GROWTH DCF MODEL ..... .................................. ... ...... ............. ........ .......... ......... ...................... 24
NON-CONSTANT GROWTH DCF MODEL ............................. .................... .................................................... 35
CAPITAL ASSET PRICING MODEL ................................ ................................. .... .... ...... ........ .. ...... ...... ... .... .. ... 38
RECOMMENDED ROE .. ........ ....................................... .. .. ........................................................... .................. 46
RECOMMENDED COST OF DEBT AND PREFERRED STOCK .......... ................................................................ 47
RECOMMENDED WACC ... ... .. ..... .... ... ..... ....... .. .. ... ........ ........ .............................................. .... .... .......... ....... . 50
SUMMARY ..... ................................ ....... ................... .. ...................................... ...... .... ............ ........ .... ...... ... . 50
Bryce J. Freeman Docket Number 20004-117-ER-16
OCA Exhibit 201
INTRODUCTION AND QUALIFICATIONS
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PLEASE STATE YOUR NAME, ADDRESS AND OCCUPATION.
My name is Bryce J. Freeman. My business address is 2515 Warren Avenue, Suite 304,
Cheyenne, WY, 82002. I am the Administrator of the Wyoming Office of Consumer
Advocate (OCA). The OCA is an independent consumer advocacy agency that was
created by an act of the legislature in the 2003 general session.
WHAT IS THE FUNCTION OF THE OCA?
Pursuant to W.S. § 37-2-401 ,
The office of consumer advocate shall represent the interests of Wyoming citizens and all classes of utility customers in matters involving public utilities. In the exercise of its powers the office of the consumer advocate shall consider all relevant factors , including, but not limited to, the provision of safe, efficient and reliable utility services at just and reasonable pnces.
ARE THE ANALYSES AND RECOMMENDATIONS OF THE OCA, IN THIS OR
ANY OTHER CASE BEFORE THE COMMISSION, INFLUENCED OR
DIRECTED BY THE COMMISSION?
No. Although the OCA is a division within the Commission according to W.S. § 37-2-
401 , it is a separate division with no reporting or supervisory links to the Commission. The
OCA has the right under W.S. § 37-2-402(ii) to appeal decisions of the Commission that it
does not find in the public interest. The only link between the OCA and the Public Service
Commission is the source of common funding provided by the assessment on gross utility
operating revenues; this assessment funds both the Commission and the OCA.
Additionally, as Administrator of the OCA, I report directly to the Governor of Wyoming.
PLEASE DESCRIBE YOUR EDUCATIONAL BACKGROUND AND
OCCUPATIONAL EXPERIENCE.
I received a Bachelor of Science degree in business administration from the University of
Wyoming in 1982. The area of concentration in my undergraduate work was statistics.
After graduating from the University of Wyoming, I was employed for three years by the
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Laramie County Treasurer as Deputy Treasurer, and then for six years by the Wyoming
Department of Revenue as a Principal Appraiser dealing primarily with utility valuation
and capital cost issues. I came to the Wyoming Public Service Commission in April of
1994, in the capacity of Senior Economist, serving in that position for approximately two
years. In 1996, I accepted a position as Lead Rate Analyst in the rates and pricing section
on the Commission Staff, and in May of2003 , I was appointed Administrator of the OCA.
In July of2004, I was appointed to a two-year term of service on the board of the Wyoming
Infrastructure Authority (WIA). In July of 2006, I was reappointed to a four year term and
in 2010, I was appointed to a second four year term on the WIA Board. In March of 2014,
after ten years of service as Secretary of the WIA Board, I rotated off of the WIA Board.
Also in 2004, I was elected to the position of Secretary of the National Association of State
Utility Consumer Advocates (NASUCA), which is a national trade association composed
primarily of state chartered consumer advocate offices throughout the country. In
November of 2010, I stepped down as NASUCA Secretary and currently serve on the
NASUCA Executive Committee. My present and past participation in both of these
organizations provides me with unique knowledge and experience upon which I can draw
in formulating advocacy positions on behalf of Wyoming utility consumers.
In 2010, I was appointed by the Board of Directors of the Western Electricity Coordinating
Council (WECC) to serve as a consumer representative on the Scenario Planning Steering
Group (SPSG). The SPSG was created to facilitate the development of a Regional
Transmission Expansion Plan (R TEP) pursuant to a contract that WECC entered into with
the U.S. Department of Energy (DOE). Funding for the RTEP project was provided by
DOE under the terms of the American Recovery and Reinvestment Act (ARRA).
Additionally, in November of 2011 , I was appointed by the WECC Board of Directors to
serve on the WECC Transmission Expansion Policy Planning Committee (TEPPC), a
WECC Board standing committee. My participation in WECC and in the RTEP project is
another source of unique and valuable insight into regional electricity issues that assist me
in advocating for the interests of Wyoming consumers.
Finally, in December of 2011 , I was elected to serve on the Advisory Council of the Center
for Public Utilities at New Mexico State University. The Center for Public Utilities (CPU)
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provides training programs and current policy issues conferences to meet the needs of
professionals employed at federal and state commissions, utility companies, and other
stakeholders in the electricity, natural gas distribution, interstate pipeline,
telecommunications and water utility industries.
HA VE YOU TESTIFIED BEFORE THIS COMMISSION IN PREVIOUS
PROCEEDINGS?
Yes. I have detailed the cases in which I have testified before this Commission in Appendix
A, attached to my testimony. I have also offered testimony before the Federal
Communications Commission, the Federal Energy Regulatory Commission and the United
States Congress.
ON WHOSE BEHALF DO YOU APPEAR HERE TODAY?
I appear here today on behalf of the OCA. As I indicated previously, the OCA is an
independent party in this proceeding, separate and apart from the Commission or its
advisory staff.
AS A MEMBER OF THE OCA, DO YOU ADVOCATE THE INTERESTS OF
CERTAIN GROUPS OF CONSUMERS OVER OTHERS?
No. As a member of the OCA, it is my statutory obligation to advocate the best interest
of all citizens in the state. Specifically, W.S. § 37-2-401 states that the OCA "shall
represent the interests of Wyoming citizens and all classes of utility customers in matters
involving public utilities. [emphasis added]" This public interest standard requires the
OCA to represent the broadest possible utility consumer constituency, even though some
of those consumers may also be represented independently as parties in this case. The
OCA is responsible for balancing the positions and recommendations of the Company,
and of other parties, to arrive at a set of recommendations that serve the overall long term
public interest.
ARE YOU SPONSORING ANY EXHIBITS IN THIS PROCEEDING?
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OCA Exhibit 201
Yes, I am sponsoring OCA Exhibits 201 .1 through 201 .5. I will identify and describe these
exhibits later in my testimony.
IN THE COURSE OF YOUR REVIEW OF THIS MATTER, DID YOU USE
INFORMATION THAT THE COMPANY DEEMED CONFIDENTIAL?
No.
DOES YOUR TESTIMONY AND/OR EXHIBITS CONTAIN INFORMATION
THAT THE COMPANY HAS DEEMED CONFIDENTIAL?
No.
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WHAT IS THE PURPOSE OF YOUR TESTIMONY IN THIS PROCEEDING?
The purpose of my testimony in this proceeding is to support the OCA's overall
recommended revenue increase in this proceeding. More particularly, my testimony will
address the appropriate rate of return to be allowed on Montana Dakota Utility Company's
(MDU or Company) invested capital, the OCA' s recommended proportion of debt and
equity capital to be included in MDU's capital structure, and the OCA's recommended
overall weighted average cost of capital (W ACC). OCA witness Mr. Anthony Ornelas will
address development of the revenue requirement in this case, and Dr. Belinda Kolb
addresses cost of service and rate design issues. In my testimony I will provide a detailed
description of the data and methods that I used to derive my recommendations in this
proceeding. I will discuss the function of capital cost in setting rates for regulated public
utilities such as MDU, general factors that influence the cost of capital required by
investors to finance utility investments and market benchmarks that provide some insight
into the range of returns currently being demanded by investors in competitive capital
markets. I will also provide a current cost of equity analysis for MDU, which I have
developed independently, that shows that the return on equity (ROE) being requested by
MDU in this proceeding is excessive and should be reduced to a level more consistent with
current capital market dynamics. I will combine my ROE recommendation with
recommendations on the appropriate cost of debt and capital structure to arrive at a
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recommended overall weighted average cost of capital (W ACC). Throughout my
testimony I will reference the testimony of Company witness, Dr. J. Stephen Gaske, who
sponsors MDU' s recommended ROE, noting some areas where he and I agree and many
areas where we disagree, and the reasons therefore.
As the Commission will recall , both Dr. Gaske and I testified regarding capital cost issues
in MDU' s 2014 request to increase revenues for its Wyoming gas operations1• My review
and analysis in this case is based on the same methods and models that I have presented to
the Commission on many occasions over the last twenty years, informed by current market
information and data. My review of Dr. Gaske' s testimony suggests that he also relies on
largely the same models and methods that he has used in past proceedings before the
Commission. Consequently, the arguments in my testimony will be very familiar to the
Commission. Still, it is my intent with this testimony to clearly identify the methodological
differences between my approach and that of Dr. Gaske to capital cost estimation, and to
give the Commission a sound basis upon which to determine the appropriate cost of capital
in this proceeding.
My testimony in this proceeding is offered in conjunction with that of Mr. Ornelas and Dr.
Kolb. The analysis and recommendations of the OCA in this proceeding are offered as a
package by the OCA and are intended to provide the Commission with a basis upon which
to make a determination consistent with the public interest in this case.
AS A PRELIMINARY MATTER, WHAT RETURN IS MDU SEEKING IN THIS
PROCEEDING?
MDU is seeking a proforma overall WACC of 7.576% as shown on Statement F, page one
of one, attached to the Company's application in this matter. MDU' s proposed capital
structure consists of 42.397% long term debt, 5.502% short term debt, 1.111 % preferred
stock and 50.990% common equity. MDU requests that the Commission approve a cost
of long term debt of 5.363%, a cost of short term debt of 1.828%, a return on preferred
1 Docket Number 30013-297-GR-14.
Bryce J. Freeman 6 Docket Number 20004-117-ER- l 6
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stock of 4.577%, and a return on common equity of 10.10%. Combining the relative
2 proportions for each of the sources of capital with MDU' s proposed cost, as described
3 above, yields a proposed WACC of7.576%.
4 COST OF CAPITAL - BACKGROUND
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WHAT IS THE FUNCTION OF THE COST OF CAPITAL IN THE CONTEXT OF
RA TEMAKING?
For ratemaking purposes, the cost of capital is the amount of profit, or return that a
regulated utility is allowed to earn on the capital, both debt and equity, that it has invested
in the utility enterprise. The utility must acquire this capital from private investors in
competitive securities markets. Those investors have a wide variety of choices regarding
where and when to invest their dollars, ranging from mutual funds to investments in
individual stocks or bonds. Private investors are driven by a desire to maximize their
returns while minimizing their risks.
For private companies not subject to rate regulation, the amount ofreturn that can be earned
is limited only by the demand for a company' s product or service, the company's ability to
supply that demand and the ability of management to acquire capital and manage costs.
For regulated utilities, on the other hand, the judgment of the regulator supplants the
operation of the competitive market in determining what level of return is sufficient to
induce investors to provide scarce capital dollars. In either case, however, the investor
makes his decision based on the expected return relative to the perceived risk of the
investment.
From this perspective setting the appropriate authorized return for regulated utilities is
exceedingly important. If the regulator sets the rate of return too low in comparison to
investors ' perceived risk, then investors will price shares of the utility lower, increasing
the yield to a level that reflects investors' market return expectations. Under these
circumstances the utility will find it difficult to attract and maintain capital investments.
Conversely, if the return is set too high, investors will price the shares higher, reducing the
yield to a level consistent with investors' perceived risk. In this way the market is self
correcting, but in the latter situation ratepayers would be needlessly burdened with higher
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rates that are not necessary to attract and maintain capital investment. This fundamental
risk return relationship applies to every market security as shown in the classic Security
Market Line (SML):
Return
Rr
Security Market Line
Equity Risk Premium
Corporate Bond Risk
Premium
T-Bond Yield
T-Bill Yield
Corporate Bond Yield
Stock Yield
Risk
The figure above graphically depicts the relationship between risk and return from a market
view point. Securities that have less perceived risk, such as U.S. Government debt
obligations also have a lower return and tend to cluster in the lower left of the graph. As
the perception of risk increases so does the market return demanded by investors. Moving
up the SML we find the returns for the corporate debt of large investment grade companies
and farther up still are the returns for the common equity of those same companies.
Although not shown in the figure, the returns for mid-size and smaller investment grade
companies would appear even further up the SML from large company stocks. Small cap
companies and non-investment grade securities would occupy the extreme upper right hand
comer of the graph. Theoretically, if one can accurately determine the difference between
any two of the points on the SML, often referred to as the "Risk Premium," then an estimate
of the market cost of capital can be made. The importance of this basic relationship
between risk and return will become even more apparent as I discuss the appropriate return
for MDU later in my testimony.
Bryce J. Freeman 8 Docket Number 20004-117-ER- I 6
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HAS THIS RELATIONSHIP BETWEEN RISK AND RETURN BEEN ADOPTED
AS A LEGAL STANDARD IN RATEMAKING PROCEEDINGS?
Yes, the critical importance of this relationship in determining an allowed rate of return
has been recognized by the U.S. Supreme Court when it established the capital attraction
and maintenance standard. This standard was established in two precedent setting cases;
Federal Power Commission v. Hope Natural Gas Co., 320 U.S. 591 (1944), and Bluefield
Water Works v. Public Service Commission, 262 U.S. 679 (1923). These cases are often
referred to collectively as the "Hope and Bluefield" standard. In Bluefield the Court found
that:
A public utility is entitled to such rates as will permit it to earn a return on the value of the property which it employs for the convenience of the public equal to that generally being made at the same time and in the same general part of the country on investments in other business undertakings which are attended by corresponding, risks and uncertainties; ....
In Hope the Court confirmed its finding in Bluefield that utility shareholders must be
adequately compensated for the risk assumed in utility investments when it found that:
..... the return to the equity owner should be commensurate with returns on investments in other enterprises having corresponding risks ....
The return should be reasonably sufficient to assure confidence in the financial soundness of the utility, and should be adequate, under efficient and economical management, to maintain and support its credit and enable it to raise the money necessary for the proper discharge of its public duties.
The Court also found, inter alia, that regulation is not a guarantee of profitability, that the
property being earned on must be devoted to public service, and that the appropriate return
to be granted depends on the facts and circumstances at the time the determination is made
and may change from time to time owing to changes "affecting opportunities for
investment, the money market, and business conditions generally".
WHY CAN'T THE COMMISSION SIMPLY SET ALLOWED UTILITY RA TES
OF RETURN AT SOME LOWER LEVEL, SAY AT A LEVEL ON PAR WITH U.S.
TREASURY RETURNS? WOULDN'T THAT BENEFIT CUSTOMERS?
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As demonstrated by the SML above, and consistent with the tenants contained in the Hope
and Bluefield decisions, investors expect to be compensated for accepting increasing
increments of risk. Securities issued by the United States Government are risk free, at least
in theory, while utility shares are not. A utility shareholder faced with the choice of holding
a U.S. Government security or a utility share with an equivalent return would certainly
choose to hold the government security and avoid the risk of holding the utility share. This
obviously does not satisfy the capital attraction and maintenance standard set out in Hope
and Bluefield. The objective then, is to determine the equity return that is just sufficient to
induce the investor to hold the utility share rather than the government security, considering
the risk that the investor assumes when holding the utility share. This is not all together a
trivial exercise as I will demonstrate in my testimony below.
Additionally, while setting low allowed rates of return for utility companies may appear to
be in customers' best interest, setting returns that chronically fail to adequately compensate
investors for the use of their capital will have the opposite effect over time. This is due to
the fact investors will perceive that the risk of owning the utility share has increased and
adjust their return expectations accordingly, ultimately driving up the cost of financing
utility operations over future periods.
18 MARKET RISK DYNAMICS
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WHAT ARE THE GENERAL FACTORS THAT INFLUENCE RISK IN
FINANCIAL SECURITIES?
There are a wide variety of factors that influence risk in financial securities as perceived
by investors. Risk that cannot be diversified away by holding a large portfolio of
diversified securities is often referred to as systematic or market risk. Market risk includes
such factors as expected levels of interest rates and inflation, monetary and fiscal policies,
and the general level of economic growth and activity anticipated by investors when an
investment decision is made. To one degree or another systematic risk affects the value of
all market securities and cannot be diversified away by holding a large portfolio of
securities.
Bryce J. Freeman 10 Docket Number 20004-117-ER-16
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Non-systematic, or business risk embodies the risk of holding a particular security and
includes factors such as the characteristics of the particular market and industry in which
the company issuing the security operates, the ability of management to generate revenue
and control costs, and the ability of the company to attract capital on reasonable terms. For
regulated utilities, business risk also includes regulatory risk or the risk that the regulator
will set rates for utility services at a level that fails to produce the return expected by the
investor when the investment was made.
Investors consider all of these risk factors when making investment decisions. The essence
of risk relative to the financial markets is the probability that realized returns will be lower,
due to the risk factors cited above, than the return anticipated by the investor when the
investment was made. The higher the probability of lower realized returns the higher the
initial return demanded by the investor. Put another way, the higher the perceived risk that
actual future returns will be lower than anticipated, the lower the present value, or price, of
the security.
WHAT IS YOUR ASSESSMENT OF THE CURRENT MARKET RISKS FACING
MDU?
There are certainly risks associated with holding the debt and equity securities of private
companies in today' s market place. The general level of expected economic activity is an
important driver in the growth, or decline as the case may be, in demand for utility services.
Economic activity can be measured broadly by examining the factors that drive economic
activity such as unemployment levels, wage and compensation levels, labor productivity,
interest rates, monetary policy, and economic output as measured by Gross Domestic
Product (GDP).
As the Commission is well aware, the nation' s economy is continuing to slowly recover
from a severe recession that began in 2008 and lasted for about two years. Since the end
of the recession, national unemployment has declined from a high of 10% in 2009 to its
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present level of 4.9%2. However, the labor force participation rate has remained stubbornly
low over that same period, declining from about 66% in 2008 to around 62.8% currently3•
In fact, recent small gains in job creation have been offset by an increasing labor force
resulting in unemployment remaining flat for the last several months. This increase in
labor force is driven primarily by a slight increase in unemployed or under-employed
workers returning to full time positions. Year over year growth in wages for the year
ending June 2016 was 2.5%4 while inflation increased at 2.3%5 over the twelve months
ending August 2016 which indicates essentially no growth in annual disposable income. It
should be noted, however, that most of the decline in the overall rate of inflation is due to
the declining price of crude oil over the last two plus years. Excluding the two volatile
categories of food and energy, the inflation rate was 1.1 % for the period ending August
20166. Generally, consumers are hesitant to make long term spending commitments based
on price reductions in these two volatile commodity categories. Since consumer spending
drives about 70% of economic activity in the U.S . economy, the level of unemployment
and the growth in wage compensation are important factors contributing the consumption
of goods and services measured by GDP.
Growth in GDP has similarly been lackluster since the recovery began in 2010. During the
period 2010 to 2014 the annual average rate of growth in real GDP (not adjusted for
inflation) has been 2.21 %7 which compares to a long term average growth in real GDP of
3.3%. The Congressional Budget Office (CBO) expects the growth in real GDP over the
period to 2026 to average 2.0%8, consistent with projections of the U.S . Department of
Agriculture which projects real GDP growth of 2.42%9 over the period to 2030. Both of
2 U.S. Department of Labor, Bureau of Labor Statistics, http://data.bls.gov/timeseries/LNS 14000000. 3 U.S. Department of Labor, Bureau of Labor Statistics, http://data.bls.gov/timeseries/LNS 11300000. 4 U.S . Department of Labor, Bureau of Labor Statistics, http://www.bls.gov/web/eci/ecicois.pdf. 5 U.S . Department of Labor, Bureau of Labor Statistics, http://www.bls.gov/news.release/pdf/cpi.pdf. 6 lbid. 7 U.S. Department of Agriculture, http://www.ers .usda.gov/data-products/intemational-macroeconomic-dataset.aspx.
8 Congressional Budget Office, THE BUDGET AND ECONOMIC OUTLOOK: 2014 TO 2024, http://www.cbo.gov/sites/defaul t/fi les/cbofi les/attachments/450IO-Outlook2014 _Feb. pdf.
9 U.S. Department of Agriculture, http://www.ers.usda.gov/data-products/intemational-macroeconomic-dataset.aspx#261 98 .
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these projections are significantly lower than the historic rate of growth in real GDP and
both reflect recent downward revisions.
According to the U.S. Bureau of Labor Statistics (BLS), labor force productivity gains
since the end of the recession have been essentially in line with average productivity gains
realized over the period from 1987 through 2013. The BLS reports that during the period
2010 through 2015 average annual growth in productivity was 2. 7% while the average over
the period 1987 through 2013 was 2.9%. 10 By contrast, productivity gains during the last
sustained economic growth period from approximately 1995 through 2000 averaged 5%.
Productivity gains in the range of 2.5% to 3.0% are consistent with the slow economic
growth that has occurred since the end of the recession and is expected to continue over
the long term as cited above.
Although U.S. monetary and fiscal policy has firmed up incrementally in the last year it is
still highly uncertain. In December of 2015 the Federal Open Market Committee of the
Federal Reserve Bank (Fed) increased its target short term interest rate from .25% to .5%.
Various observers have speculated in recent years that the Fed would begin increasing rates
to levels more consistent with the historic range. For context, in 2008 the Fed short-term
interest rate stood at a level over 5%.
However, in succeeding quarterly meetings over the intervening year the Fed has declined
any further increases in its short-term rate target. In relaying its rate decisions to the public
the Fed has repeatedly cited labor market challenges, the lack of productivity increases,
nascent inflation and slow underlying national and global economic growth as headwinds
for the U.S . economy. Absent a rapid improvement in these metrics the Fed is likely to
pursue a course of cautious and deliberate monetary tightening over a period of the next
several years.
As the economy has continued on its slow trajectory of recovery, and the Fed has
implemented one incremental increase, it would be reasonable to expect an increase in long
10 U.S. Department of Labor, Bureau of Labor Statistics, http://www.bls.gov/mfp/mprdload.htm.
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term interest rates, the interest that is paid on long dated bonds and other securities used by
utilities and industrial companies to finance large capital investments. However, no such
market effect has been observed. In fact, after the Fed increased its short-term target rate
last December, interest rates on corporate debt have actually declined significantly as
shown in the chart below 11 :
FRED.d - 30.Year Treasury Constant Maturity Rate - Moody's Seasoned Baa Corporate Bond Yield()
Moody's Seasoned Aaa Corporate Bond Yield()
6.0
s.s
5.0
4.5
c . 4.0 " ?:. 3.5
3.0
2.5
2.0 2015-10-01 201 5-11 -01 201S-12-01 2016-01 -01 2016-02-01 2016-03-01 201 f>-04-01 2016-05-01 2016-0f>-01 2016-07-01 201 f>-08-0 1 201 &-09-01
fred.stloulsfed.m g myf.red/g/7uWV
Rates on long term corporate and government debt are lower now than they were during
the period of aggressive monetary intervention by the Fed, as shown in the graph below12 :
11 Federal Reserve Bank of St. Louis, FRED Economic Data, http://research.stlouisfed.org/fred2/graph/?id=WGS30YR.
12 Ibid.
Bryce J. Freeman 14 Docket Number 20004-1I7-ER- I 6
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OCA Exhibit 201
FRED,.,c:: - 30-Year Treasury Constant Maturity Rate - Moody's Seasoned Baa Corporate Bond Yieldtl
Moody's Seasoned Aaa Corporate Bond Vleld!C
10
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
fred.stloulsfed.org myf.red/g/7uXd
WHAT DOES ALL OF THIS PORTEND FOR THE FUTURE OF THE UTILITY
INDUSTRY?
Based on the information discussed above, it certainly appears that the U.S. economy can
expect an extended period of slow economic growth. Since energy is a basic input into the
production of goods and services, the fortunes of the utility industry are tied quite closely
to the health of the overall economy and it is likely that utilities will see subdued growth
quite similar to that of the overall economy. Electric load growth, for example, is likely to
be flat or declining for an extended period of time lessening the need for utilities to finance
large capital investments in new generation and transmission infrastructure. In tum this
will lessen the construction and financing risk that utilities, including MDU, would
otherwise face if demand were increasing. The prospect for slow growth is reflected in the
projections of professional equity analysts which I will discuss in detail later in my
testimony. For example, in its July 29, 2016 summary of the electric utility industry, Value
Line found that 13:
And it's not as though the industry's growth rate is accelerating. On the contrary, load growth for many utilities is anemic.
13 Value Line Investment Survey, Electric Utility (West), July 29, 2016, page 2226.
Bryce J. Freeman 15 Docket Number 20004-117-ER- l 6
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14 Ibid.
OCA Exhibit 201
In that same edition, Value Line goes on to state that14:
Low interest rates are mostly positive for utilities. Investors are seeing what effect this has on stock prices. Utilities borrowing costs are much lower too. The downside is that, when utilities receive rate orders low interest rates mean that their allowed returns on equity are also low. Today it is not unusual to see an electric company's allowed ROE below 10%. Note, too, that earned ROEs are usually below allowed ROEs. Nevertheless, the advantages of low interest rates outweigh the disadvantages.
Investors choose to hold equity shares for a number of reasons but, a relatively important
element of an investor' s decision to invest in a particular share is the growth in dividends
and share price appreciation expected to be derived from owning the share. This is
particularly true for utility companies which typically pay out a greater proportion of their
earnings in the form of dividends than the average publicly traded company. Since a
utility ' s ability to grow dividends is directly correlated with its ability to grow earnings it
is the potential growth in earnings that is of interest to investors. Generally speaking there
are two ways to grow earnings; increase revenue or cut cost. In today' s economic
environment, with flat to declining loads and diminished need for large capital investments
it will be difficult for utilities to grow revenue. Cost containment can be an effective way
to increase earnings in the short term but there is a limit to how much costs can be cut
before service quality and reliability suffer. Prospective growth, both for privately held
companies, including utility companies, as well as the overall economy, is likely to be quite
low for the foreseeable future. Investors recognize this and have priced shares accordingly.
IS THERE EVIDENCE THAT WE CAN OBSERVE IN THE MARKET THAT
SUPPORTS THIS HYPOTHESIS?
Yes, a simple examination of market dividend yields supports this hypothesis in general
terms. The dividend yield is simply the ratio of expected dividends in the next period to
the current stock price. The current dividend yield on the dividend paying stocks included
Bryce J. Freeman 16 Docket Number 20004-117-ER-16
OCA Exhibit 201
in the S&P 500 stock index is currently 2.07% 15 while the yield on the Dow Jones Utilities
2 Index is 3.4%. 16 This strongly suggests that utility equity investors understand that
3 prospects for growth in the utility industry are limited in comparison to the broader market,
4 thus they demand more of their return upfront in the form of dividend yield in order to
5 balance the value of utility shares against the value of alternative equity investment
6 opportunities that may have lower expected dividends but higher potential for growth. It
7 should be noted, however, that the dividend yield for a sample of comparable utility shares
8 tracked by the Value Line Investment Survey was 5 .19% at the time of MDU' s 2009
9 electric rate case17. So, even though utility dividend yields are much higher than those of
1 o the broader market, they have in fact declined, consistent with declining yields in the
11 broader market, indicating a general decrease in investors' perceived risk.
12 BUSINESS RISK
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Q. WHAT ARE THE RISKS PECULIAR TO THE ELECTRIC UTILITY INDUSTRY
OR MDU ITSELF THAT ARE NOT REFLECTED IN THE RISK FACTORS
THAT YOU HA VE ALREADY DISCUSSED?
16 A. In addition to the market risk factors discussed above, MDU is also subject to certain
discrete risk factors that do not factor into overall market risk. As I discussed earlier in my
testimony, business risk is attributable to such factors as the particular industry and market
in which a company operates, the ability of the company and its management to grow
earnings, and the degree to which the company' s financial policies either enhance or
degrade its prospects to grow earnings in the future.
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For example, a company that operates in a relatively small geographic area, such as MDU' s
electric service territory, can expect to be dependent to a greater degree on the health of the
local economy than a company that operates in a larger territory within a state or in multiple
15 Mutpl.com, S&P 500 Dividend Yield, http: //www.multpl.com/s-p-500-dividend-yield/. 16 Dow Jones Utility Average Fact Sheet,
http: //www.djindexes.com/mdsidx/downloads/fact_ info/Dow _Jones_ Utility_ Average _Fact_ Sheet.pdf 17 Docket Number 20004-81-ER-09, Direct Testimony of Kimber Wichmann on behalf of the Wyoming Office of
Consumer Advocate, Exhibit KMW 4.
Bryce J. Freeman 17 Docket Number 20004-117-ER-16
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OCA Exhibit 20 I
states. Rocky Mountain Power, for instance, which operates in many states, is able to
diversify the risk of a cyclical economic downturn in any particular service area in which
it operates since it is likely that some or all of its other service areas would experience a
contemporaneous counter-cyclical upturn. In both cases, however, utility shareholders
would benefit from the fact that MDU and Rocky Mountain Power are both afforded the
protection of the regulatory compact that does not inure to non-regulated companies.
Similarly, from a business risk perspective, MDU benefits from its association with MDU
Resources, a very large and diversified holding company. Being a part of the MDU
Resources corporate family in effect allows MDU Utilities to diversify away a large part
of the shareholder risk that would otherwise be present if MDU Utilities were a stand-alone
company.
IS THERE ANYTHING ABOUT MDU'S SHERIDAN AREA SERVICE
TERRITORY THAT WOULD MERIT AN INCREASED RISK PREMIUM?
No. In spite of the statewide downturn in the energy complex, of which we are all well
aware, MDU's Sheridan service area seems to be remarkably resilient and stable. Sheridan
County's mineral tax valuation has dropped by approximately 90% since 2009 after
reaching a high of about $400 million. State and local property taxes, on the other hand,
have exhibited modest growth over that same period 18 . Sheridan County's median
household income has been trending up incrementally and is slightly lower than the median
for Wyoming but slightly more than the median U.S. household income 19• The poverty
rate in Sheridan County has also been trending lower2°. The county's school enrollment is
up by about 8% over the last five years21, while the county's overall population has grown
18 Community Builders, Inc., Focus on Sheridan, January 2016, http://www.consultcbi .com/uploads/7 /6/4/4/7644909l /sheridan_2016-9.pdf. 19 Community Builders, Inc., Focus on Sheridan, February 2016, http://www.consultcbi.com/uploads/7 /6/4/4/76449091 /sheridan_2016-9 .pdf. 20 Ibid. 21 Ibid.
Bryce J. Freeman 18 Docket Number 20004-117-ER-16
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OCA Exhibit 20 I
by almost 11 % over the last decade22, slightly slower than the state overall. Sheridan
County' s work force has remained fairly stable at around 15,000 employed residents23 and
unemployment in the county stood at 4.1% at the end of July 2016, approximately 100
basis points lower than the Wyoming and U.S. unemployment rates24. The county has also
experienced modest but positive wage gains over the last several years25.
Based on this data, I conclude that there is no reason to ascribe any special risk premium
to the cost of financing MDU's Sheridan County electric utility operations. Rather, I
believe MDU's Wyoming service territory is stable and is characterized by modest but
predictable growth. The cyclical downturn in the energy market, while it has obviously
negatively impacted the operations of other utilities in Wyoming, does not appear to have
had a material impact on MDU's Wyoming operations. As such, I believe it is reasonable
to use a sample set of comparable companies to infer equity financing costs for MDU
without making any special risk premium provisions. I will discuss the concept of
comparability later in my testimony.
DO YOU AGREE WITH DR. GASKE'S ASSERTION THAT THE SMALL SIZE
OF MDU'S WYOMING UTILITY OPERA TIO NS WARRANT A LARGE RISK
PREMIUM IN COMPARISON TO OTHER UTILITIES?
Absolutely not. Dr. Gaske argues that based on Ibbotson Associates data, unregulated
firms that are similar in size to MDU's Wyoming electric operations enjoy a size premium
of 1,430 basis points over the average return on long term corporate bonds and that his
recommended ROE is low in comparison.26 Dr. Gaske further argues that a size premium
adjustment of at least 100 basis points over the return required by the typical [electric]
proxy company is warranted, although he provides no basis upon which to conclude that a
22 Community Builders, lnc., Focus on Sheridan, August 2016, http: //www.consultcbi.com/uploads/7 /6/4/4/76449091 /sheridan_2016-9 .pdf. 23 Community Builders, Inc ., Focus on Sheridan, September 2016, http://www.consultcbi.com/uploads/7 /6/4/4/76449091 /sheridan_20 16-9 .pdf. 24 Ibid. 25 Ibid. 26 Direct Testimony of J. Stephen Gaske, page 26.
Bryce J. Freeman 19 Docket Number 20004-117-ER-l 6
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OCA Exhibit 201
100 basis point size premmm is any more appropriate than a 1430 basis point size
premium27.
What Dr. Gaske fails to recognize is that MDU is not a small cap company comparable to
those referenced in the Ibbotson publication. Investors cannot purchase a share of equity
in MDU Resources that represents only the Wyoming electric utility operations. Rather,
when investors purchase an equity share of MDU Resources they are purchasing the right
to receive dividends derived from the earnings of all of MDU Resource's operations. MDU
Resources is a large diversified holding company with a market capitalization of
approximately $4.6 billion which Value Line classifies as a "mid cap" company.
If Dr. Gaske wishes to estimate the required return for only the Wyoming electric
operations of MDU Resources there are other, more accurate ways to do so. For example,
Dr. Gaske could have performed what is commonly called a divisional cost of capital
analysis. Dr. Roger Morin devotes an entire chapter in his book "New Regulatory Finance"
to the topic of "Divisional Cost of Capital and CAPM Applications".28 As discussed by
Dr. Morin there are many techniques that can be used to estimate the required return on
discrete assets or operations oflarger companies. Most of these techniques revolve around
attempting to measure the difference in risk, primarily on a subjective basis, between the
assets or operations held as part of a larger corporate family and the estimated risk if they
are assumed to be held and operated as a stand-alone enterprise. The most common
measure of risk in a divisional cost of capital analysis is beta which is a statistical measure
of the price volatility of equity shares in comparison to the overall market. I will describe
the application of beta as a measure of risk in more detail later in my testimony. But for
now, this brief description provides a convenient segue into my next point regarding Dr.
Gaske's flawed logic on the subject of size premia.
27 Direct Testimony of J. Stephen Gaske, page 32. 28 New Regulatory Finance, Dr. Roger Morin, Chapter 7.
Bryce J. Freeman 20 Docket Number 20004-117-ER-16
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As correctly pointed out by Dr. Gaske, nearly all of the companies tracked by Ibbotson in
its size premia deciles are unregulated companies and not comparable to utility companies
generally or MDU utilities specifically. This is obvious when one observes the average
betas associated with each of the deciles taken from the Ibbotson Associates 2016 SBBI
Yearbook29. For example, Ibbotson calculates the average beta for companies included in
the smallest sized market capitalization decile, where MDU' s utility operations would fall
if viewed on a stand-alone basis, to be 1.39. The resulting size premium for companies in
this decile, as recommended by Ibbotson, is 5.60%, or 560 basis points, not the 1,430 basis
points suggested by Dr. Gaske.
We can see from the average beta, however, that even this size premium adjustment is
inconsistent with any measure of comparable risk. Companies comprising this decile are
the smallest of the small, almost entirely unregulated companies, and as such exhibit betas
that are wholly incomparable to that of regulated utilities. For instance, the average beta
for the electric and combination electric and gas distribution companies followed by Value
Line is 0.72. The market is assumed to have a beta of 1.0 implying that the Value Line
electric and combination utilities are, on average 28% less risky than the market. With a
beta of 1.40, Dr. Gaske would have us believe that MDU' s Wyoming gas operations are
40% more risky than the market overall, simply due to its small size. By contrast, my
proxy group of comparable companies, the derivation of which I will describe later in my
testimony, have an average beta of 0.74. These are highly regulated companies that derive
a majority of their revenue from electric and natural gas utility operations and are far more
comparable than the unregulated companies contained in the smallest market cap size
decile published by Ibbotson.
To put an even finer point on this argument, the companies that comprise the top decile of
capitalization, the largest of the large, have an average beta of 0.91 , considerably higher
than the average for the Value Line gas and electric companies. Ibbotson suggests that the
29 2014 Cost of Capital Handbook; Guide to Cost of Equity, Duff & Phelps, LLC.
Bryce J. Freeman 21 Docket Number 20004-117-ER-16
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size premium for these companies should actually be negative at -0.36% meaning that the
market risk premium should be adjusted downward for companies of this size and risk.
Assuming an average beta more consistent with that of the regulated utilities followed by
Value Line would suggest that the size premium advocated by Dr. Gaske should, in fact,
be negative.
Based on the forgoing discussion, it is my opinion that attempting to make a size premium
adjustment based on published size premium data for regulated utilities in general, and
specifically for MDU in this proceeding, is inappropriate and will lead to a gross
overstatement of the required market equity return for MDU in this case. Importantly, one
of the methods for properly assessing the required return on equity for an operating division
of a larger diversified company, as discussed by Dr. Morin in his book, is the "Pure Play"
method. In this method the analyst seeks to estimate ROE using financial and market data
from proxy companies that are as nearly comparable as possible to the subject operating
division. As I will describe later in my testimony that is essentially the method that I have
used to arrive at my recommended ROE in this proceeding.
HOW SHOULD INVESTMENT RISK BE ACCOUNTED FOR IN A COST OF
EQUITY ANALYSIS?
In the development of my recommendations on cost of capital I assess the risk faced by the
utility in the same manor that investors assess risk, on a relative basis. It is a relatively
simple matter to identify individual factors that might influence the risk faced by a subject
utility. The question then becomes; are those risks extraordinary or in addition to the risks
being faced by similarly situated companies. Going back to the tenants of the Hope and
Bluefield decisions, a utility return should be comparable to those of similar companies
attended by similar risk. As I indicated earlier in my testimony, I can find no rational basis
upon which to attribute greater risk to MDU than the companies in my proxy group and
therefore recommend an ROE that is consistent with the expected returns for my proxy
group.
Bryce J. Freeman 22 Docket Number 20004-117-ER-16
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COMPARABLE COMPANIES
Q.
A.
IN LIGHT OF THE FOREGOING DISCUSSION OF RISK, HOW DID YOU
BEGIN YOUR ANALYSIS OF THE APPROPRIATE ROE FOR MDU?
I began my analysis in this proceeding, as I customarily do, by gathering data from the
Value Line Investment Survey (Value Line) on the forty three companies classified by
Value Line as electric utilities or combination electric and natural gas utility companies.
Unlike Dr. Gaske who included only electric companies in his proxy, I included
combination electric and natural gas utilities in my proxy group since MDU is a
combination electric and natural gas utility. Excluding combination utilities which are
comparable in practice to MDU would unnecessarily limit the sample size of comparable
companies (Value Line lists only 17 natural gas distribution companies) increasing the
probability that the data will not be random and truly representative of MDU.
The object of this exercise is to gather publicly available financial information for
companies that are as comparable to MDU as possible so that information can be used to
generate a cost of equity estimate. As outlined in the Hope and Bluefield cases discussed
earlier, MDU is entitled to a return on its investment in plant and facilities devoted to public
utility service that is commensurate with returns being earned by comparable companies
with similar risk. The sample group of companies, after incomparable companies are
eliminated, will become the basis of the comparative analysis required under Hope and
Bluefield.
From Value Line I gathered such information as capital structure, growth in earnings,
dividends and book value, estimated dividends, estimated return on equity and estimated
earnings per share. I supplemented the Value Line information with information on bond
ratings and the relative percentage of regulated revenues for the companies in Value Line.
I obtained share price information from the Wall Street Journal Online Edition and, in
addition to Value Line, I took analyst's earnings growth forecasts from Yahoo Finance and
Zacks Investment Research both of which are available online.
After gathering this data on the forty-one companies followed by Value Line I screened
the companies to assure comparability with MDU. First, I eliminated companies for which
Bryce J. Freeman 23 Docket Number 20004-117-ER-16
OCA Exhibit 20 I
I could not obtain complete and useful financial information from Value Line.
2 Additionally, since MDU Resource' s (MDU's parent company) bond rating is BBB+ from
3 S&P (MDU is not rated by Moody's Investor Service), I restricted the companies in my
4 sample group to those with a bond rating of at least BBB from S&P. I also eliminated
s companies with unstable financial histories and for which dividends and earnings are not
6 expected to grow in the future. I also required each of the proxy companies to derive at
7 least 70% of their total revenue from regulated utility operations; many of the combination
8 electric and gas companies in my sample derive more than 70% of their operating revenue
9 from electric operations.
10 Finally, I also eliminated companies that are currently engaged in merger or acquisition
11 activities. Such activity tends to skew the price that investors are willing to pay for a share
12 of the utility based on anticipated gains or losses resulting from the merger or acquisition
13 rendering any comparison made against that company unreliable. The resulting set of
14 fifteen companies shown in OCA Exhibit 202.1 are highly comparable to MDU. Dr.
15 Gaske 's ROE estimate relies on eleven proxy companies, only three of which are included
16 m my proxy group.
17 CONSTANT GROWTH DCF MODEL
18 Q.
19 A.
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27 Q.
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WHAT WAS THE NEXT STEP IN YOUR ANALYSIS?
Following my selection of a suitable group of sample companies I calculated various
indicators of the cost of equity capital for each, including the basic Constant Growth
Discounted Cash Flow (DCF) model, three versions of the multi-stage DCF (NCDCF)
model, and a Capital Asset Pricing Model (CAPM) indicator. I also calculated a quarterly
compounding version of the DCF model. However, my quarterly DCF model is
substantially different than that of Dr. Gaske. I will describe the theoretical underpinnings,
data requirements, assumptions used and results of each of these indicators in my testimony
below.
PLEASE DESCRIBE THE CONSTANT GROWTH DCF MODEL AND ITS
RESULTS.
Bryce J. Freeman 24 Docket Number 20004-117-ER-16
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Certainly. The premise of the DCF model is that investors make their decision to invest in
the equity shares of a company based on the present value of the future cash flows expected
to be derived from the investment. Reducing the future cash flows to a present value
enables investors to easily compare available investment opportunities. Notationally, the
classic DCF formulation is expressed as follows:
On Dn(1-g)
Po= + + x 1+K (1 +K)2 K-g
9
Where: K = Cost of Equity
Di = Dividend in Period 1
Po = Current Stock Price
g = expected growth in dividends
The DCF model noted above can be simplified and expressed in the form traditionally used
by investors to ascribe a price to a share of stock which embodies all of the future cash
flows that the owner expects to receive as a result of the ownership of that share. The
traditional share valuation model is expressed as follows :
n
Pa=L t= l
01 +g (1 +K)t
Where: All variables are as previously listed
As can be seen from this derivation, the investor is interested in ascertaining the price that
should be paid for a share given that the investor already knows what rate he or she will
use to discount the future revenue stream and what growth rate can be expected in the form
of growth in dividends and share price appreciation. The regulator, however, is interested
in determining the implicit discount rate and rate of growth given the observable price that
the investor is willing to pay. This valuation model can be manipulated algebraically to
solve for the discount rate K and expressed as follows :
Bryce J. Freeman 25 Docket Number 20004-117-ER-16
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K= --12L + g Po
Where: All variables are as previously listed
OCA Exhibit 201
This expression is the standard form of the constant growth DCF model. It is appealing
and deceptively simple because it relies on readily available market observations for the
current price and expected dividends to derive the current dividend yield (D J!Po in the
above equation). The difficulty arises in assigning a value to growth, g. Growth is the rate
at which investors expect future dividends and share price to grow over an infinite holding
period. While some argue that price, Po, should be averaged over some historical period
from a few days to a few months, and others argue that dividends, D 1, should be estimated
on a quarterly rather than annual basis, it is the estimation of g that typically generates the
most controversy in regulatory proceedings.
For his part, Dr. Gaske uses a six month historic average of the share prices for the
companies in his comparable group in calculating the dividend yield for each of his proxy
companies. I continue to believe that using a share price as near to the rate effective date
as possible is a much better reflection of investors' perceived risk than an average of prices
over some arbitrary historical period. Investors' decisions are based on current
expectations about future returns and the current price efficiently and effectively
incorporates those expectations; historical prices, even over a short period, may be
significantly disconnected from investors' expectations about the future, particularly in
periods characterized by market volatility. Therefore, I have used the closing spot price as
of September 1, 2016 to represent the price component of the dividend yield in the constant
growth DCF model set out above, as shown in Column M of OCA Exhibit 201.1. For the
expected dividend component of the current dividend yield I use Value Line's projected
2017 dividend. This is consistent with the construct of the annual constant growth DCF
model which calls for expected dividends in the next period (year). The calculated
dividend yield for each company is shown in Column N of that same exhibit.
As shown in Column 0 of that exhibit, I also made an adjustment to the dividend yield of
each company to reflect the costs associated with issuing equity. Similar to the issuance
of utility debt securities there is a cost associated with issuing equity, for example, legal,
Bryce J. Freeman 26 Docket Number 20004-117-ER-16
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underwriting and marketing expenses. For debt instruments these fees are customarily
included in the cost of debt and amortized over the life of the security. For equity however,
there is no obligatory schedule of dividend payments and therefore it is necessary to adjust
the dividend yield in order to properly reflect the fact that expenses are incurred in the
issuance of equity. Ignoring those costs deprives the utility of earning a full return on its
outstanding equity, if only by a very small amount.
In developing my floatation cost adjustment I relied on the data provided in Dr. Gaske's
Exhibit JSG 2, Schedule 2, which is a computation of the actual floatation costs associated
with equity issuances by electric companies over the period 2005 to 2015. The
approximate average of the floatation costs, 3.3%, associated with these issuances is
reasonably consistent with floatation costs estimates that I have seen in the past and I have
no reason to question their validity. I do object, however, to the way in which Dr. Gaske
incorporates his floatation cost estimate into his DCF analysis.
Dr. Gaske mistakenly multiplies the end result of his basic DCF calculation by 1.03330 to
account for floatation costs, effectively increasing his estimated ROE by as much as 50
basis points. The appropriate method to account for floatation costs, on the other hand, is
to adjust the dividend yield in the DCF model to account for floatation costs as follows: 31
r=D1/P(l-f) + g
The difference between the standard DCF model and the floatation adjusted model is that
the dividend yield, D1 /P, is divided by 1- f (floatation cost estimate). This is because the
cost of issuing equity reduces investors' yield but does not impact the future growth
expected by those same investors. The treatment of growth between the two models is
identical. The example in the table below shows the magnitude of Dr. Gaske's mistake,
assuming a dividend yield of 3%, floatation costs of 4% and growth of 5%:
30 Direct testimony of J. Stephen Gaske, Exhibit JSG 2, Schedule 4. 31 New Regulatory Finance, Dr. Roger Morin, page 328.
Bryce J. Freeman 27 Docket Number 20004-117-ER-16
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Basic DCF Floatation Adjusted DCF Gaske Floatation Adjustment
r = Di/P + g r=(D1/P +g)x(1 - f)
.03 + .05 = .08 = 8% (.03/.96) + .05 = .08125 = 8.125% (.03 + .05) x 1.04 = .0832 = 8.32%
My flotation cost adjustment effectively adjusts the estimated cost of equity upward by
increasing the dividend yield by an average of approximately 15 basis points. Dr. Gaske's
erroneous adjustment increases the indicated cost of capital produced by the standard DCF
model by about 30 basis points.
WHAT ESTIMATE OF GROWTH HAVE YOU USED IN CALCULATING THE
CONSTANT GROWTH DCF MODEL?
There are several methods that an equity analyst can use to estimate the growth component
required in the constant growth DCF model. I'll begin with earnings growth estimates
provided by professional equity market analysts. Professional equity market analysts
follow the shares of many publicly traded companies. By analyzing the underlying
performance of the issuing company, equity analysts project future performance according
to such metrics as revenues, returns, earnings and dividends per share, price earnings ratio,
and others. These analysts routinely publish their projections in the trade press and those
projections are widely relied upon by investors when formulating their investment
decisions. They are also a widely used source of information for Commissions in making
return determinations in cases such as the instant case.
I have used three separate sources of analysts' growth estimates in my constant growth
DCF model; Value Line, Yahoo Finance and Zacks Investment Research. The five year
earnings growth estimate, which is the longest projection made by analysts, is shown in
Columns P, S and T of OCA Exhibit 201.1. I rely exclusively on earnings growth estimates
in my analysis because earnings provide the cash with which dividends are paid and
because Value Line is the only estimating service that provides dividend growth estimates;
Yahoo and Zacks provide only earnings growth estimates. In theory, assuming a constant
dividend payout ratio, earnings and dividends would grow at the same rate in any event. I
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should note that Dr. Gaske uses analysts ' estimates from Yahoo and Zacks and does not
consider the earnings growth estimates provided by Value Line.
I weighted the growth estimates from each reporting source equally in my calculation of
the constant annual growth DCF model. The results of my constant growth DCF indicator
using analysts' projections of growth, and adjusting for floatation costs, are shown in
Column AF of OCA Exhibit 201 .1. The median constant growth DCF indicator for the
proxy group is 9.22%
DID YOU CONSIDER OTHER METHODS OF ESTIMATING GROWTH IN
YOUR ANALYSIS AS WELL?
Yes, I also incorporated a long term projection of GDP growth based on both historic and
estimated growth in GDP into the various versions of my constant growth DCF model. In
addition, I also included an estimate of sustainable growth in one version of my constant
growth DCF model. I will describe all of these indicators more fully below.
Incorporating growth in long term GDP as a proxy for growth in the DCF model is based
on the premise that over the very long term a company's earnings growth cannot be
sustained at a level higher than that of the overall economy. During shorter periods
earnings may grow faster or slower than GDP but over the long term earnings will revert
to the mean level of growth for the economy as a whole. From a theoretical perspective
the theory is sound. But, in practice it has precisely the same short-coming as that of other
methods of projecting growth; specifically, estimating the rate of future GDP growth.
Historic GDP growth is well documented and widely available in the public domain. For
example, the Federal Reserve Bank of St. Louis provides information on both nominal and
real GDP growth from 1947 to the present.32 During this period GDP growth averaged
6.4%, ranging from a high of 13% in 1978 to a low of -2% in 2007. Between 1990 and
2007 nominal GDP growth ranged generally between approximately 4% and 6%. The
32 Federal Reserve Bank of St. Louis, http://research.stlouisfed.org/fred2/categories/l 06.
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graph below shows nominal GDP growth over the period 1953 to present as well as
projected GDP to 2026;
.r:. .. :: 0 ... l!> Q.
0 l!>
14.0%
12.0%
10.0%
8.0%
6.0%
4.0%
2.0%
0.0%
-2.0%
-4.0%
Nominal GDP Growth
- GDP Growth
As I have done in past cases in which I have testified before the Commission, I have relied
upon the historic nominal GDP growth rate data provided by the Federal reserve bank of
St. Louis for the period 1953 to present, weighted to more recent years, in formulating my
estimate of future GDP growth based on actual historic GDP growth.
In my analysis I have weighted each observation according to its chronological place in the
data set. For instance, the observation for 1953 gets only one sixty second of the weight
of the observation for 2015 in my analysis. My method considers all observations in the
data set but gives proportionally more weight to more recent GDP growth rates. My
analysis results in an estimated GDP growth rate of 3 .1 % based on weighted historic
nominal growth in GDP over the period 1953 to 2015. Incorporating this estimate of
growth into my constant growth DCF model results in a median estimated cost of equity
of 6.40% for my sample group of companies as shown in Column AG of OCA Exhibit
201.1.
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DO YOU BELIEVE THAT THIS A REASONABLE ESTIMATION OF LONG
TERM GDP GROWTH IN THE FUTURE?
None of us knows with any degree of certainty how GDP will grow in the future,
particularly over the type of infinite time horizon assumed in the DCF model. Therefore,
we are required to make some assumptions and judgments to arrive at a growth rate that
reasonably represents a plausible future growth rate. After all, we are trying to measure
investors ' expectations about the future since the exercise of measuring capital cost is
meant to support the capital attraction and maintenance standard established in the Hope
and Bluefield cases. It is not unreasonable to assume that future growth, both for individual
companies and the economy in general, will follow the same broad patterns that it has in
the past. From that perspective, my estimate of GDP growth based on historic observation
is plausible, but there are certainly other estimates of future GDP growth that may be a
more accurate representation of investors' future expectations for growth. In weighing this
particular indicator I give it no weight in my final estimation of ROE for MDU.
WHAT OTHER ESTIMATES OF GDP GROWTH HAVE YOU CONSIDERED IN
YOURDCF ANALYSIS?
Although there are many sources of GDP growth estimates, some public and some private,
I have used the estimates provided by the Congressional Budget Office (CBO) in its
publication: The Budget and Economic Outlook: 2015 to 2025. The CBO is a non-partisan
organization that provides budget, monetary, economic and policy analysis to the U.S.
Congress. Its analysis and estimates are widely relied on by Congress, Federal Agencies
and the private sector in formulating spending and investment decisions. The CBO' s
analytical methods are as credible as any other available source. The CBO estimates that
U.S. GDP will grow at an annual average rate of 4.0% over the period 2014 through 2026
with real GDP growth averaging 2.0%. This implies an annual average rate of inflation of
2%.
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I also looked at GDP growth estimates developed the USDA as referenced earlier in my
testimony. 33 In its analysis the USDA estimates that real GDP will grow at an average rate
of approximately 2.42% over the period to 2030. The USDA' s analysis is based on
information from the World Bank, the International Monetary Fund, IHS Global Insights
and Oxford Economics, among others. If inflation continues to average 2% over that same
period then nominal GDP growth will average about 4.6% to 2024, consistent with the
estimates provided in the CBO publication discussed above. Although both the CBO and
USDA expect GDP growth to increase slightly this year, both organizations expect GDP
growth to resume a lower stable pattern of growth in the later years of the forecast period.
Incorporating the CBO's estimate of annual average nominal GDP growth into my constant
growth DCF model results in a median estimated cost of equity of 7.30% as shown in
Column AH of OCA Exhibit BJF 201.1.
IS THE CBO ESTIMATE OF FUTURE GDP GROWTH CREDIBLE AND
REASONABLE IN YOUR OPINION?
Absolutely. As I indicated earlier, the CBO's economic and budget projections are widely
used and relied upon by both government and private entities. Some market analysts argue
that some government forecasts for lower GDP growth are biased downward since they are
based on an assumption of permanently low inflation of around 2%. In fact, Dr. Gaske
suggests that inflation wi 11 increase in the future and by extension long term interest rates
will rise as well. 34 However, a 2% annual inflation rate is widely recognized as the inflation
rate that the Federal Reserve Bank's Federal Open Market Committee (FOMC) is targeting
with its monetary policy tools. It is also identical to the inflation rate of 2.0% implicitly
incorporated into the CBO's GDP growth projections.
As further support for the efficacy of a long term inflation rate in the range of 2% we need
only observe in the market what actual investors expect inflation to be over the long term.
33 United States Department of Agriculture, Economic Research Service, http://www.ers.usda.gov/dataproducts/international-macroeconomic-data-set.aspx.
34 Direct Testimony of J. Stephen Gaske, page 13 .
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The U.S. Treasury issues 30 year Treasury Bonds which are currently yielding about 2.4%
(as of October 6, 2016). It also issues 30 year Treasury Inflation Protected Securities
(TIPS) which are currently yielding 0.67%. Purchasers of 30 year Treasury Bonds, if held
to maturity, will earn the coupon rate on the face of the bond. Purchasers of TIPS earn a
return that is indexed to the rate of inflation. The difference between the yield on a 30 year
bond and a TIPS is the implicit rate of inflation expected by real investors investing real
dollars in Treasury securities. The current difference, 1.77% (2.435% - 0.671% = 1.764%),
representing investors ' expected inflation rate, is even lower than the inflation rate assumed
by the CBO in its long term GDP projections and the Federal Reserve Bank's target
inflation rate. In my view, the GDP growth projections made by the CBO are both
reasonable and credible and if anything may tum out to be high given the outlook for
inflation.
DID YOU CONSIDER ANY OTHER GROWTH PROJECTIONS IN YOUR
CONSTANT GROWTH DCF ANALYSIS?
Yes, I also looked at a projected rate of growth based on the sustainable growth rate
approach similar to that provided by Dr. Gaske. Sustainable growth is based on the premise
that future growth in dividends (which are derived from earnings) can only occur if a
portion of the earnings that would otherwise be paid out in dividends is reinvested in the
company.35 The level of sustainable growth (aka the retention ratio growth method) is
expressed as:
g = bxr
where "b" is the fraction of earnings retained and "r" is the expected return on the book
value of equity. Value Line publishes expected earnings and dividends per share from
which a retention ratio (b in the above equation) can be derived, as well as the expected
return on equity. These calculations are shown in Columns U through Y of Exhibit OCA
35 New Regulatory Finance, Dr. Roger Morin, page 303 .
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201.1. The resulting median sustainable growth rate of 4.20% is shown at the bottom of
Column Y of that exhibit. Combining the sustainable growth rate with the floatation
adjusted dividend yield for each company in my sample group produces an estimate of the
cost of equity for MDU of 7 .68% as shown in Column AE of OCA Exhibit 201.1 .
IS THIS A RELIABLE METHOD OF PROJECTING GROWTH?
It can be. But, just like all other methods and sources, it has its short comings. The
information that I have used from Value Line to calculate sustainable growth is projected
information. There is always an element of uncertainty associated with projections.
Additionally, the Value Line projections are the work of a single analyst rather than a
consensus of many analysts, making those projections less reliable than, for example, the
multiple analysts ' opinions I include in the analysts' growth rate forecast that I described
earlier. Finally, analysts are predicting earnings growth in the range of 5.4% and the CBO
is predicting GDP growth in the range of 4.0%. At 4.2% the sustainable growth rate is in
the range of both analysts' and government forecasts for growth. I should also note that
Dr. Gaske recommends a much lower retention growth rate, approximately 3.65%36, than
I do. However, Dr. Gaske then blends this lower growth rate with higher analyst growth
rates to arrive at a blended growth rate in excess of 5%37
Since Dr. Gaske and I both use the same methodology and Value Line source data to
compute our respective sustainable growth rate estimates, it appears that the difference in
the two estimates is related primarily to the proxy groups that we are using. Dr. Gaske
limits his proxy group of comparable companies to electric utility companies and
consequently his sample group is smaller than mine. For the reasons discussed earlier in
my testimony I also include combination electric and gas utilities in my proxy group. There
36 Direct Testimony of J. Stephen Gaske, Exhibit JSG 2, Schedule 4, page 4. 37 Direct Testimony of J. Stephen Gaske, Exhibit JSG 2, Schedule 4, page 5.
Bryce J. Freeman 34 Docket Number 20004-117-ER- l 6
OCA Exhibit 201
also may be some minor differences in our sustainable growth estimates due to the fact that
2 I used the most current edition of Value Line to make my sustainable growth estimate.
3 NON-CONSTANT GROWTH DCF MODEL
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DID YOU ALSO CONDUCT DCF ANALYSES BASED ON THE PREMISE THAT
GROWTH IS NOT CONSTANT INTO PERPETUITY?
Yes. I computed three versions of the non-constant growth DCF model incorporating
different combinations of the various growth rates discussed previously. The non-constant
growth DCF (NCDCF) model is predicated on the assumption that dividends will grow at
some constant rate in the near term and a constant but different rate thereafter. For this
analysis I have assumed that analysts ' growth rate projections are the most reliable
estimation of growth over the next five years and that after the initial five year period,
growth will revert to the long term mean growth rate of GDP, either based on historical
observations or based on the estimates provided by the CBO as discussed earlier. I also
developed an NCDCF estimate based on my sustainable growth estimate.
Essentially, my NCDCF model is an Internal Rate of Return (IRR) calculation that projects
the cash flows associated with owning a share of the equity of each of the companies in my
sample group over the next 150 years. This is technically not an infinite time period but is
certainly longer than the useful life of utility assets or the investment time horizon of the
typical utility equity investor. Notationally, the internal rate of return is given by r in the
following equation:
iV
NP\l = ~ C,. ~(l+ r)n
Where: NPV = net present value n = period n
=0
N = total number of periods Cn = cash flow in period n
The IRR function iteratively solves the above equation for r, or the discount rate that
equivocates all future cash flows to the NPV or the current share price, expressed as a
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negative cash flow. The results of my NCDCF calculations are shown in Exhibits OCA
BJF 201.2, 201.3 and 201.4. Each of these exhibits begins with the five year analyst growth
forecast described earlier and substitutes the CBO estimated GDP growth rate, the long
term historic GDP growth rate, and the sustainable growth rate, respectively, for the second
stage or long term growth rate. As shown on the exhibits, the results of my NCDCF
analyses range from 7.0% to 7.84%.
DID YOU ALSO CONDUCT A QUARTERLY DCF ANALYSIS?
Yes, as I mentioned earlier in my testimony, I also conducted a quarterly DCF analysis.
The quarterly DCF model is a slightly modified version of the basic constant growth DCF
model discussed extensively above. In the quarterly DCF model the fact that public
companies typically pay dividends on a quarterly basis is accounted for in calculating the
dividend yield. Therefore, the quarterly DCF model takes the form38:
K=
[d1(l +K)';. + d2(1 +Kf 2 + d3(1 +K) ';. + d4]
Po
Where: K = Cost of Equity
d = Dividends in Quarters 1 -4
Po = Current Share Price
g = Growth
+ g
The essence of the quarterly compounding DCF model is that since dividends are paid on
a quarterly basis they are available to be reinvested, also on a quarterly basis, thus
compounding their value to the shareholder. This concept is not unlike what is experienced
when on places money in an interest bearing account that pays compound interest. For
example, most pass-book savings accounts pay interest on the amount in the account at the
end of the period, including any interest payments paid in previous periods. In this way
the account pays interest not only on the original principal sum invested (simple interest)
38 New Regulatory Finance, Dr. Roger Morin, page 344.
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but on the accumulated interest as well (compound interest). The quarterly compounding
DCF model is based on exactly the same premise.
The quarterly DCF model is solved iteratively, which is made much easier using a
computer spreadsheet application. Essentially, one substitutes values for K on the right
side of the equation until those values exactly equal Kon the left hand side of the equation.
In OCA Exhibit BJF 202.5, Columns AI through AL, I show the results of my quarterly
DCF analysis, again showing results based on the four different growth estimates discussed
earlier in my testimony. I should also note that I have again adjusted the yield in my
quarterly DCF model to reflect floatation costs. The results of my quarterly DCF analysis
range from 6.35% to 8.51 %.
DO YOU HAVE ANY OBSERVATIONS REGARDING DR. GASKE'S
QUARTERLY DCF ANALYSIS?
My understanding of Dr. Gaske ' s quarterly DCF analysis is that it is actually not a quarterly
compounding DCF model at all. Rather, Dr. Gaske assumes that the next dividend to be
received by investors will be received between one and three months hence and simply
assumes that his estimate of growth will apply to dividends paid after that time. In effect,
Dr. Gaske is merely adjusting the dividend to reflect an arbitrary point during the next
period (year) when dividends will grow. This in no way accounts for the compounding
effect that would occur if one assumes that dividends are reinvested on a quarterly basis.
To be sure, if dividends are expected to grow during the period (year) then the growth in
dividends should be accounted for as well. But, that is an entirely separate matter from the
compounding that results from quarterly dividend reinvestment. In my analysis I have used
projected dividends for 2017, hence no adjustment is necessary. As a practical matter,
privately held companies, including those in my proxy group, typically make dividend
distribution decisions on an annual basis (usually in the first quarter of the calendar year),
even though those dividends are generally paid on a quarterly basis. And, again, the growth
in the projected dividend has nothing to do with the compounding that results from
quarterly dividend reinvestment.
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CAPITAL ASSET PRICING MODEL
Q.
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WHAT OTHER INDICATORS OF THE COST OF EQUITY CAPITAL HAVE
YOU COMPUTED IN YOUR ANALYSIS IN THIS CASE?
I have also calculated a Capital Asset Pricing Model (CAPM) indicator of the cost of equity
capital for MDU. The CAPM is a discrete version of the more general risk premium model.
As I discussed earlier in my testimony, the premise of the security market line is that
investors are willing to assume additional increments of risk only in return for the
opportunity to earn additional returns. The risk premium is the quantity of additional return
demanded by investors in return for the additional risk assumption. Using this relationship
an estimate of the cost of equity capital can be made using the following equation:
Where: K =Cost of Equity RF= Risk Free Rate RM= Market Risk Premium r., =Beta
In theory, if the risk premium for a specific security can be estimated, in comparison to an
alternative security, that risk premium can be combined with the present return for the
comparative security to derive an estimate of the market cost of capital. In practice, historic
risk premiums are compiled and published by a number of private and public sources. In
my analysis I relied on data compiled by Ibbotson Associates (Ibbotson) over the period
1926 to present. Previously, the "Ibbotson SBBI Yearbook; Stocks, Bonds, Bills and
Inflation" published by Morningstar ceased publication. It is now back in print and is being
published by Duff & Phelps, a widely recognized source of financial and market
information. Dr. Roger Ibbotson is the author of the 2016 edition of the Ibbotson SBBI
Yearbook.
Ibbotson provides historic risk premiums that measure the differential return between the
stock market and long term government and corporate bonds over the period 1926 to 2015
(other periods are provided but not used in my analysis). According to Ibbotson, the
incremental return or risk premium of stocks over long term government bonds demanded
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by investors over that 89 year period averaged 6.0%.39 Thus one measure of the current
cost of capital, based on the current return of long term government bonds of 2. 79% would
be 8.79% (2.79% + 6.00% = 8.79%) for the average equity share.
The above calculation, however, is only a generalized estimation of the cost of equity
capital. It is widely recognized that shares of stock are characterized by substantially
different levels of risk. In order for the risk premium to be useful for our purposes we need
a way to more definitively measure the risk associated with the shares of utility companies,
and even more specifically, the risk associated with the shares of the companies in my
sample group.
The CAPM measures this share specific risk by measuring the share price volatility of the
subject shares in comparison to the overall market. In theory, shares that are affected with
less risk will exhibit lower share price volatility over time than riskier shares and shares
with higher risk will exhibit relatively more price volatility. This share price volatility
measure is known as beta and is denoted by /!, in the above equation. The overall market
is assumed to have a beta of 1. Beta is a measure of the covariance of individual shares
with the overall market. For example, shares with a beta of 1 would have prices that vary
precisely in tandem with the market and thus in theory would have the same level of risk
as a widely diversified portfolio of stocks. Shares with a beta greater than one exhibit share
price volatility greater than that of the market in general and are said to be riskier than the
overall market. Conversely, share price volatility less than 1 indicates that a particular
share possesses less risk than the overall market.
Incorporating beta, which I have taken from the data published in Value Line, into the
above equation, we see that utility stocks have demonstrably lower risk than the overall
market; the median beta for the companies in my sample group is 0. 70 or 30% less than
the overall market. The median beta for the companies contained in Dr. Gaske's proxy
group is 0.75 or 25% less than the overall market. Combining beta with the currant risk
39 2014 Cost of Capital Handbook; Guide to Cost of Equity, Duff & Phelps, LLC, Chapter 3, page 14.
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free rate of 2.279% and the market expected equity risk premium of 6.0%, pursuant to the
above equation, yields an estimate of the cost of equity for each of the companies in my
sample group. As shown in Column AK of OCA Exhibit 201 .1, the resulting median cost
of equity capital is 7 .18%.
DO YOU HA VE ANY OBSERVATIONS REGARDING DR. GASKE'S RISK
PREMIUM ANALYSIS?
Yes. As I explained earlier in my testimony, Dr. Gaske ' s risk premium analysis, wherein
he compares the historic returns of small company stocks to the historic returns on
corporate bonds is meaningless in the context of setting rates in this proceeding. Dr. Gaske
does not present this risk premium analysis as an indicator of the cost of equity for MDU,
but rather as a benchmark, presumably to underscore the reasonableness of his final
recommended ROE.
In his risk premium analysis Dr. Gaske erroneously concludes that the small company
stocks followed by Ibbotson's are a good proxy for MDU. As I demonstrated earlier, those
small company stocks are not even slightly comparable to MDU and any incremental size
premium derived therefrom is highly inappropriate. Dr. Gaske' s two additional risk
premium benchmarks suffer from the same basic defect, specifically, they are based on the
returns of companies that are not even remotely comparable to that of a regulated utility.
For his large company risk premium calculation Dr. Gaske relies on the large company
stocks followed by Ibbotson' s. Ibbotson' s lists the ten largest of those companies by decile
in its 2015 SBBI Y earbook40. According to the Ibbotson' s, the largest company in decile
1 is Apple, Inc., the computer, software and cell phone giant. Aside from the fact that
Apple has a total market capitalization of $629 billion while MDU Resources, MDU
Utility' s parent company, has a total market capitalization of $4.6 billion, there is no
40 2015 SBBI Yearbook; Stocks, Bonds, Bills and Inflation, Ibbotson, Chapter 7, page 4.
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comparison between the lines of business of Apple and MDU, either at the parent level or
at the utility level. Further, Apple is not a rate of return regulated utility. Any attempt to
compare the required return on equity for MDU to that of Apple, or any other non
comparable company for that matter, is fruitless in this proceeding. The Commission
should reject Dr. Gaske ' s attempt at comparing MDU to private, unregulated companies
that are in no way comparable to the regulated utility operations of MDU.
The same is true for Dr. Gaske ' s attempt to compare MDU' s utility operations to the
broader market as represented by the S&P 500. Dr. Gaske performs what he calls a
"capitalization weighted DCF calculation" based on the dividends and growth projections
of the company' s contained in the S&P 500 Stock Index4 1Again, while there may be some
utility companies represented in the S&P 500, the vast majority of the companies in the
S&P 500 are not regulated utilities, do not have business operations or services that even
remotely resemble the utility operations of MDU, and are otherwise not directly
comparable to MDU' s utility operations.
One final point regarding Dr. Gaske 's risk premium analysis. Dr. Gaske develops his risk
premium benchmarks by comparing the incremental difference in the historic returns of
stocks (large and small) over the historic returns of long term corporate bonds. While in
theory a valid risk premium can be developed based on this information, there are some
practical problems that Dr. Gaske ignores in his analysis.
First, leading authorities on cost of capital estimation, including lbbotson's and Dr. Morin,
advocate that risk premiums be based on a risk free security. The most common risk free
rates used in equity cost estimation in rate setting proceedings are those of U.S. government
bonds. These are the only securities that have no risk of default and match the investment
horizon of most utility assets. Corporate bonds, even those that are highly rated, possess
some degree of default risk.
41 Direct Testimony of J. Stephen Gaske, p. 27, lines 1-9.
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Secondly, those same authorities advocate that the proper return to use is the income return
since this is the return that the investor expected to earn when the investment was made.
Historic corporate bond returns, such as those published by Ibbotson' s, contain not only
the income return but the appreciation of the bond as well. In order to properly develop an
accurate risk premium based on these corporate bonds the price appreciation element must
be removed from the total return. Ibbotson' s does not remove the price appreciation
element from its index of historic returns for corporate bonds and Dr. Gaske made no
attempt to do so either. Consequently, Dr. Gaske ' s risk premium benchmarks are
overstated, notwithstanding the other substantial concerns I have with his risk premium
analysis.
ARE GENERAL MARKET RETURNS OF ANY VALUE AT ALL IN
PREDICTING REQUIRED RETURNS FOR INDIVIDUAL SHARES?
As I will explain in the following section of my testimony, broader market returns are only
useful in that they give one a general sense of the appropriate range of reasonable returns
for discrete shares. Relying on such broad returns as basis for making a point estimate of
the ROE for any particular share is an exercise in futility. Even so, it is exceedingly
important to appropriately frame the range ofreasonable returns which Dr. Gaske has failed
to do in this proceeding.
19 ROE BENCHMARKS
20 Q.
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WHAT IS THE RANGE OF EQUITY COST ESTIMATES INCLUDED IN YOUR
ANALYSIS?
My analysis shows that the appropriate cost of equity for MDU at this time falls somewhere
in a range of reasonableness between 6.88% and 10.59% with the mid-point of the range
being 8.24%. Of course, all of these equity cost indicators have their own individual
theoretical and practical strengths and weaknesses. History may or may not repeat itself
and can be considered only a rough guide of what may happen in the future. Likewise,
projections, particularly those made over the time horizon required by the DCF model,
while informed by various sources of data, have a speculative element to them that should
not be understated.
Bryce J. Freeman 42 Docket Number 20004-117-ER-16
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Q. ARE THERE ANY BENCHMARKS THAT YOU CAN OFFER THE
A.
COMMISSION TO ASSIST IN NARROWING THE RANGE OF
REASONABLENESS FOR THE COST OF EQUITY IN THIS CASE?
There are a couple of benchmarks that I believe the Commission can rely upon in helping
it to narrow the range of reasonable equity cost estimates in this proceeding. Importantly,
I am not recommending that the Commission use these benchmarks in place of its own
sound decision making process or its informed judgment based on the evidence in this
proceeding. Rather, I am suggesting that these benchmarks may be useful to the
Commission in calibrating its compass with regard to the range of reasonable alternatives.
First, Ibbotson publishes two historical risk premium measures in its annual SBBI
Yearbook; the " Long-Horizon Equity Risk Premia" and the "Supply-Side Equity Risk
Premia". Ibbotson provides a thorough description of both of these risk premia which I
will only briefly summarize here. The long-horizon equity risk premium is essentially the
index that used to form the basis for my CAPM calculation discussed earlier in my
testimony expressed more generally. In this risk premium estimate Ibbotson uses average
stock market total returns over the period 1926 to 2015 and subtracts the average long-term
government bond return over that same period to arrive at an expected Equity Risk
Premium (ERP) of 6.90%. Adding to this risk premium an amount that reflects current
long-term risk free rates, in this case the current yield on 30 year U.S. Treasury Bonds of
2.452% (as of October 6, 2016), results in an estimated cost of equity capital for the overall
market of 9.352% (6.90%+2.452%=9.352%).
Ibbotson also publishes a "Supply-Side" estimate of the market equity premium. Supply
side models are based on the theory that market returns are supplied by corporate
productivity including earnings, dividends and capital gains. Ibbotson finds that in the long
run " . . . investors should not expect a much higher or lower return than that produced by
the companies in the real economy"42. In other words, investors should expect a return that
42 2015 SBBI Yearbook; Stocks, Bonds, Bills and Inflation, Ibbotson, Chapter 10, page 27.
BryceJ. Freeman 43 DocketNumber20004-117-ER-16
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mirrors the returns in the real economy over the long term as measured by a broad index
such as GDP. This is the same theory that underpins some of the analysis that I presented
earlier in my testimony regarding the DCF model. Ibbotson then uses this supply side
information to forecast total returns for the market over the period 1926 to 2015. Ibbotson
estimates the long-term equity risk premium for the market overall, using the supply-side
model to be 6.03% on an arithmetic basis. Combining that equity risk premium estimate
with the current long-term risk-free rate of 2.452% results in a predicted cost of equity
capital for the market overall of 8.48% (6.03%+2.452%=8.48%).
Such an Expected Risk Premium (ERP) would apply to all market equities from Toys R
Us to Boeing Aerospace. Certainly, the Commission would want to rely on a much deeper
analysis, such as the one I have done, in making a determination in this proceeding. But,
it is informative to understand that the premia data published by Ibbotson forms a range
from 8.48% to 9.352% within which an 8.9% cost of equity for MDU would be considered
reasonable. My recommended cost of equity in this proceeding is very near the mid-point
of this range while Dr. Gaske' s recommended ROE of 10.10% is well above this range.
Another source of information on the general level ERPs is published by Dr. Aswath
Damodaran who is a Professor of Finance at the Stem School of Business at New York
University. Dr. Damodaran' s work is cited extensively in the trade press. According to
data compiled by Dr. Damodaran, the implied historic market risk premium, based on
dividend yields and expected earnings growth, is 6.12% 43. These risk premiums are
estimated based upon a simple 2-stage Augmented Dividend discount model and reflect
the risk premium which would justify the current level of the index, given the dividend
yield, expected growth in earnings and the level of the long term bond rate. Dr.
Damodaran' s analysis covers the period 1960 to 2015.44
43 Dr. Aswath Damodaran, Discount Rate Estimation, Implied Equity Risk Premiums - United States http:! /pages.stern .nyu.ed u/- adamodar/New _Home_ Page/data.htm I. 44 Ibid.
Bryce J. Freeman 44 Docket Number 20004-1I7-ER-16
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Given Dr. Damordaran's implied ERP, one can derive a current equity cost estimate simply
by combining the ERP with a current measure of the risk free rate, again the yield on 30
year U.S. Treasury Bonds (as of October 6, 2016) of 2.452%. This results in an estimated
cost of equity capital for the broader market of 8.572% ( 6.12%+ 2.452%=8.572% ).
Dr. Damodaran also provides a spreadsheet model which disaggregates the cost of equity
by industry sector. The model is based on a CAPM analysis conducted by Dr. Damodaran.
Without changing any of Dr. Damodaran's input assumptions the model generates a cost
of equity for the utility sector (minus water utilities) of 5.57%. In this model run Dr.
Damodaran assumes a risk free rate of 2.27% (consistent with prevailing T-bond rates at
the time the model was updated in January of 2016) and an average utility industry beta of
.55. I reran the model with the current rate for 30 year U.S. Treasury Bonds and an average
industry beta more consistent with that published by Value Line (. 70). The resulting equity
cost estimate for the utility industry, using Dr. Damodaran's CAPM model, is 6.65%. This
is certainly lower than Dr. Damodaran's estimated ROE for the broader market and much
lower than Dr. Gaske's recommended ROE range.
While these benchmark studies are not definitive, I believe they provide a frame of
reference for the Commission in examining the recommendations made by both I and Dr.
Gaske in this proceeding. Examining the information provided by both Ibbotson and Dr.
Damodaran demonstrates that returns for U.S. equities are in the range of 8.5% to 9.3%.
Since utility equity shares are less risky than the equity market overall, we know that
returns for utility shares will be lower than the return for the market overall. In fact, Dr.
Damodaran estimates utility equity returns in the range of 6%. By way of contrast, Dr.
Gaske is recommending a range of equity returns for MDU in this case from 7.10% to
12.94%. Dr. Gaske's benchmark analysis indicates a range ofreasonable returns for MDU
that ranges from a low of 10.12% to a high of 20.00%. My research and analysis in this
case demonstrates that both Dr. Gaske's benchmarks and his recommended ROE are
excessive and should be reduced to a level more consistent with current capital market
conditions.
Bryce J. Freeman 45 Docket Number 20004-117-ER- l 6
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RECOMMENDED ROE
Q.
A.
WHAT DO YOU CONCLUDE IS A REASONABLE ESTIMATE OF THE COST
OF EQUITY CAPITAL FOR MDU?
Based on my analysis in this case, as well as the general economic and market risk
information discussed in the first portion of my testimony, together with the benchmark
information provided by Ibbotson and Dr. Damodaran, I have concluded that an 8.9% cost
of equity will balance the interests of customers in just and reasonable rates and the interest
of the utility in supporting its ability to attract and maintain capital. Although I have
calculated a number of indicators of the market cost of equity for MDU, all have their own
strengths and weaknesses. In the final analysis, I have relied more heavily on the traditional
indicators, the constant growth DCF model, the long term CAPM, and the non-constant
growth DCF model, with primary reliance on those indicators that incorporate analyst ' s
forecasts to estimate growth.
I am cognizant of the fact that popular opinion seems to support rising interest rates.
However, given that markets are very efficient, and investors are, on average, very capable
of rapidly assimilating market information, my belief is that the prospect for rising interest
rates in the future has largely already been priced into securities by investors. If investors
know, for example, that an increase in market interest rates is imminent, they would pay a
smaller price for lower returns today and forego the opportunity for greater returns when
interest rates rise. This, in tum, drives up the yield of securities in the current market.
Given my range of preferred estimates, which range from 7 .18% (CAPM) to 9 .22% (DCF),
and in consideration of my overall range which would certainly support a lower
recommended ROE, I find that an 8.9% ROE for MDU is reasonable. My recommended
ROE also falls in reasonable proximity to the range specified by both Ibbotson and Dr.
Damodaran. In contrast to my recommendation, Dr. Gaske recommends an ROE of 10.1 %
selected from his identified range that runs from 7.10% to 12.94%. Based on the evidence
that I have reviewed in my analysis, I believe that Dr. Gaske is looking in the wrong range
for a return that appropriately reflects the market and financial risks that inure to MDU's
Wyoming service territory. In my opinion, the appropriate range of reasonable equity
Bryce J. Freeman 46 Docket Number 20004-117-ER- I 6
OCA Exhibit 201
returns is much lower, between approximately 8.5% and 9.25%. My recommended ROE
2 falls comfortably in that range.
3 RECOMMENDED COST OF DEBT AND PREFERRED STOCK
4 Q.
5
HAVING RECOMMENDED AN APPROPRIATE ROE, WHAT IS YOUR
RECOMMENDATION AS TO THE OTHER ELEMENTS OF CAPITAL AND
6 FOR THE COMPANY'S CAPITAL STRUCTURE?
7 A. Although the cost of debt and preferred stock is discussed by both Dr. Gaske and Mr.
8 Vollmer on behalf of MDU, it is Mr. Vollmer who presents evidence in support ofMDU's
9 proposed capital structure, cost of debt, both long term and short term, and the cost of
10 preferred stock. According to Mr. Vollmer' s testimony, and Statement F attached to the
11 application, MDU is proposing a proforma cost of capital based on a test year ending
12 December 31, 2016. Accordingly, Mr. Vollmer's proposed capital ratios and costs reflect
13 those that the Company expects to be outstanding at year end 2016.
14 MDU's proposed proforma capital structure is as follows:
Long Term Debt 42.397%
Short Term Debt 5.502%
Preferred Stock 1.111%
Common Equity 50.990%
15 The actual capital structure, on an average basis, of the companies represented in my proxy
16 group is as follows:
Long Term Debt 51.23%
Preferred Stock 0.60%
Bryce J. Freeman 47 Docket Number 20004-117-ER-16
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Q.
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OCA Exhibit 201
Common Equity 48.17%
The long term and short term debt proposed by MDU, in combination, represent 47.899%
of invested capital while common equity represents 50.990% of invested capital, both
remarkably close to the median capital ratios for those capital elements in my proxy group
of companies. Since preferred equity is debt like in as much as the dividend payments on
preferred stock are contractual obligations for MDU, the preferred stock can be combined
with debt for purposes of comparison to the proxy group. Combining the debt and preferred
stock results in a debt ratio to total capitalization of 49.010%, nearly identical to that of my
proxy group. Because MDU's proposed proforma capital structure is so similar to that of
my proxy group of companies, I am recommending that the Commission adopt that
proposed capital structure for rate setting purposes in this case and I have used it in deriving
myWACC.
Regarding the cost of the vanous capital components, I have already provided my
independent analysis supporting a cost of equity of 8.9%. I have reviewed the material
provided by MDU supporting its cost of both long term and short term debt and find the
cost of each to be reasonable. The calculation of the proforma cost of long term debt of
5.363% is shown Statement F, Schedule F-1 , page 3of5 and the calculation of the cost of
short term debt of 1.828% is shown on Statement F, Schedule F-1 , page 5 of 5. Although
it is somewhat unique in my experience for a utility to break out short term debt separately
from long term debt, I do not take exception to this approach in this case.
MDU'S EMBEDDED PROFORMA COST OF DEBT APPEARS TO BE HIGHER
THAN CURRENT MARKET DEBT COSTS FOR SIMILARLY RATED
COMPANIES. WHY ARE YOU NOT RECOMMENDING AN ADJUSTMENT TO
REDUCE MDU'S DEBT COSTS?
Statement F, Schedule F-1 , page 3 of 5, shows the derivation of MDU's proposed
embedded proforma cost of debt. As can be seen on this schedule MDU has $580 million
of long term debt outstanding at the end of the proforma test year at interest rates ranging
from 3.78% to 6.33%. Importantly, MDU issued $50 million of debt in September of2016
at an anticipated rate of 4.70%. This issue will replace two $25 million outstanding issues
with rates of 6.61 % and 6.60%, respectively. This indicates to me that MDU has tracked Bryce J. Freeman 48 Docket Number 20004-117-ER-l 6
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the favorable interest rate environment with its most recent issuances. The 6.66% issue,
the highest rate issue outstanding before it was retired, was issued in 2009 at the height of
the financial crisis when market liquidity and credit availability was particularly low. In
his testimony Mr. Vollmer indicates that since MDU' s last rate case, it has reduced its long
term debt cost from 6.868% to 5.363%.45
While it would be nice if the Company were able to refinance its higher cost issues and
bring its debt cost down even further, it would be inappropriate to assume, for the purpose
of setting rates in this case, that MDU has acted inappropriately by not doing so. Managing
capital contributions is much more complicated than simply issuing new debt or stock to
fund capital expansion or refinance existing capital outlays. New issues of stock and debt
have a cost associated with them, as I discussed earlier in my testimony. Additionally,
existing debt may have redemption limitations or unamortized costs associated with them.
Company' s must constantly review these factors to determine whether it is more beneficial
to refinance existing debt at a lower rate, given the costs involved, or simply continue to
pay the higher rate of the existing debt until such time as refinancing becomes economic.
This is not unlike the analysis that a homeowner would undertake when considering
whether or not to refinance a mortgage in view of the potential costs and limitations on
doing so.
There is no indication in the information provided by MDU in this proceeding that it has
acted imprudently in acquiring debt financing for its utility operations. I am confident that
MDU will continue to manage its debt cost through refinancing as those opportunities
become available in the market so as to minimize the cost of debt. For these reasons I do
not object to MDU' s proposed cost of debt and have included it in my calculation of the
W ACC in this case.
45 Direct Testimony of Jason L. Vollmer, page 4.
Bryce J. Freeman 49 Docket Number 20004-117-ER-16
OCA Exhibit 201
RECOMMENDED W ACC
2 Q. 3
4 A.
5
WHAT IS YOUR RECOMMENDED WEIGHTED AVERAGE COST OF
CAPITAL FOR MDU IN THIS CASE?
My recommended W ACC for MDU in this case is shown in the table below:
%of Total Weighted
Component Ca ital Cost Cost LT Debt 42.397% 5.363% 2.274% ST Debt 5.502% 1.828% 0.101% Preferred 1.111% 4.577% 0.051% Equity 50.990% 8.900% 4.538% Total 100.00%
WACC 6.964%
6 SUMMARY
7 Q.
8 A.
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PLEASE SUMMARIZE YOUR TESTIMONY IN THIS PROCEEDING.
Certainly. My testimony in this proceeding provides an independent analysis of the current
market cost of capital that I recommend be used in setting MDU's rates for retail electric
service in the Company's Sheridan, Wyoming service territory. Mr. Anthony Ornelas of
the OCA incorporates my recommended W ACC in deriving his recommended revenue
requirement in this proceeding. Dr. Belinda Kolb provides testimony and
recommendations regarding MDU's cost of service and rate design proposals.
In my analysis I take no exception to MDU' s proposed capital structure, cost of debt or
cost of preferred stock. I am, however, recommending a return on equity of 8.9%, 120
basis points less than that recommended by Dr. Gaske on behalf of the Company. In
formulating my recommended ROE I have relied on several well vetted and widely used
equity cost estimation models incorporating multiple sources of financial and market data.
These are the standard tools and methods that I have presented to the Commission in many
previous cases. It is my belief that an 8.9% ROE will appropriately balance the interests
Bryce J. Freeman 50 Docket Number 20004-117-ER-16
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OCA Exhibit 20 l
of customers in reasonable rates and the interests of the Company in accessing capital on
reasonable terms, as required by the Hope and Bluefield standard.
In reviewing the testimony of Dr. Gaske on behalf of the Company I have noted several
areas of disagreement between he and I, as well as mistakes made by Dr. Gaske in
formulating his ROE recommendation. It is interesting to note that if one dismisses the
floatation cost adjustment erroneously applied by Dr. Gaske in his DCF analysis, his
median DCF equity cost estimate (blended growth rate) for MDU is very similar to mine.
And, although Dr. Gaske' s presents three risk premium analyses and a market DCF
analysis in his testimony, purportedly to benchmark his 10.1 % ROE recommendation, they
are meaningless in the context of this rate proceeding. I continue to believe that Dr.
Gaske 's range of expected equity returns is unreasonable and by extension his
recommended ROE is excessive. I strongly urge the Commission to adopt my
recommended ROE of 8. 9% instead.
DOES THAT CONCLUDE YOUR TESTIMONY IN THIS PROCEEDING?
Yes, it does.
Bryce J. Freeman 51 Docket Number 20004-117-ER-16
BEFORE THE PUBLIC SERVICE COMMISSION OF WYOMING
IN THE MATTER OF THE APPLICATION ) OF MONTANA-DAKOTA UTILITIES ) CO. FOR A GENERAL RATE INCREASE ) IN ITS WYOMING ELECTRIC UTILITY ) SERVICE)RATES OF $3 ,225 ,447 PER ) ANNUM )
Docket No. 20004-117-ER-16 (Record No. 14409)
AFFIDAVIT, OATH AND VERIFICATION
Bryce J. Freeman (Affiant) being of lawful age and being first duly sworn, hereby deposes and says that:
Affiant is the Administrator of the Office of Consumer Advocate which is a party intervenor in this matter pursuant to its Notice oflntervention filed on June 20, 2016.
Affiant prepared and caused to be filed the foregoing testimony. Affiant has, by all necessary action, been duly authorized to file this testimony and make this Oath and Verification.
Affiant hereby verifies that, based on Affiant' s knowledge, all statements and information contained within the testimony and all of its attached schedules are true and complete and constitute the recommendations of the Affiant in his official capacity as Administrator of the Wyoming Office of Consumer Advocate.
Further Affiant Sayeth Not.
Dated this 12th day of October, 2016.
STATE OF WYOMNG ) ) SS:
COUNTY OF LARAMIE )
Bryce J. eema i\.dministrator Wyoming Office of Consumer Advocate 2515 Warren Avenue, Suite 304 Cheyenne, WY 82002 (307) 777-5742
The foregoing was acknowledged before me by Bryce J. Freeman on this 12th day of October, 2016. Witness my hand and official seal.
My Commission Expires: ft? _ d l/ , f 7 N~i)~
ANGELA D. ELLIOTT • NOTARY PUBLIC
COUNTY OF fl STATE OF LARAMIE . . WYOMING
MY COMMISSION E IRES JUN. 24. 2017
Page I of2
APPENDIX A
CASES IN WHICH BRYCE FREEMAN HAS PRESENTED TESTIMONY BEFORE THE WYOMING PUBLIC SERVICE COMMISSION AS OF 10/13/2016
Subject Hearing Of
Docket Number Com~anx Date Testimonx
30016-GR-94-8 Pinedale Natural Gas Company 10/26/1994 ROR 70006-TR-94- l 4 Silver Star Telephone Company, Inc. 12/6/1994 ROR 20002-ER-95-48 Black Hills Power & Light 8/ 14/1995 ROR, !RP, DSM, AFOR 70000-TR-95-238 U S WEST Communications, Inc. 10/2/1995 TSLRIC
General Order No. 73 Commission Rule Making 4/11 /1996 TSLRIC 20000-ER-95-99 PacifiCorp, Inc. 6/ 17/1996 ROR, AFOR, PBR 70007-TR-95- I 5 Dubois Telephone Company 8/5/1996 ROR, TSLRIC 30012-GR-96-33 Wyoming Industrial Gas Company 10/ 16/1996 ROR 70007-TR-95-15 Pacific Telecommunications, Inc. 12/ 10/1996 TSLRIC 70000-TT-96-30 I U S West Communications, Inc. 1/ I0/1997 AFOR, Jurisdiction 70007-TR-95-15 US West Communications, Inc. 1/28/1997 TSLRIC, RA TE DESIGN
70000-TR-96-323 U S West Communications, Inc. 5/26/1997 TSLRIC, Imputation 30005-GR-97-5 l Cheyenne Light, Fuel & Power, Inc. 8/25/1997 ROR 70011-TR-97-15 Tri-County Telephone Association, Inc. 3/31 /1998 TSLRIC 70014-TR-97-7 TCT West, Inc. 3/31 /1998 TSLRIC 80007-WR-98-6 Vista West Water Company 8/31 /1998 Cost of Service
20000-EA-98-141 PacifiCorp, Inc. 71611999 Merger 30010-GR-99-47 Questar Gas Company I 0/28/1999 ROR, Revenue Requirement 20003-ER-99-54 Cheyenne Light, Fuel & Power, Inc. 1/18/2000 ROR, Rate Design 30005-GR-99-53 Cheyenne Light, Fuel & Power, Inc. 1118/2000 ROR, Rate Design 20000-ER-99-145 PacifiCorp, Inc. 1/26/2000 ROR, Rate Design 80007-WR-99-8 Vista West Water Company 3/22/2000 Rate Design 300IO-GA-01-56
Questar Gas Company/Wyoming Industrial Gas 6/12/2001 Merger/Acquisition 30012-GA-O 1-43 20000-ER-O- l 62 PacifiCorp, Inc. 7/9/2001 Rate Design
70000-T A-99-482 Qwest Communications 9/6/2001 TSLRIC 70000-T A-0 I-700 Qwest Communications 3/ 15/2002 TELRIC 70013-TR-02-l 7 All West Communications, Inc. I 0/28/2002 TSLRIC 70006-TT-00-43 Silver Star Telephone Company, Inc., Teton
12/17/2002 TSLRIC 70016-TA-02-21 Telecom 20000-ER-02-184 PacifiCorp, Inc. 117/2003 Power Cost
30022-Gl-02-3 Kinder Morgan, Inc. 21312003 Choice Gas 20000-ER-02-198 PacifiCorp, Inc. 1/16/2004 Power Cost 20000-EA-05-226 MEHC/PacifiCorp 12/ 15/2005 Merger/ Acquisition 30022-73-GR-06 Kinder Morgan, Inc. 9118/2006 ROR 20000-250-EA-06 Rocky Mountain Power 1/10/2007 A voided Costs 30022-84-GA-06 Source Gas/Kinder Morgan/KMRUH; Knight
2/ 18/2007 Sale/ Acquisition/Reorganization 30085-85-GA-06 HoldCo LLC, Knight Acquisition Co.
30016-41 -GR-06 Pinedale Natural Gas Company 3/21/2007 General Rate Case/ROR 10016-47-CR-06 WYRULEC 71212007 General Rate Case 20003-90-ER-07
Cheyenne Light, Fuel & Power, Inc. 10/22/2007 General Rate Case/WY GEN II Prudence 30005-112-GR-07 70009-294-TT-07 Embarq Communications 11 /2/2007 Access Charges/USF I 0016-47-CR-06 WYRULEC 12/ 10/2007 Amended General Rate Case
20000-277-ER-07 Rocky Mountain Power 3/3/2008 General Rate Case/ROR 20000-264-EA-06 Rocky Mountain Power 5/27/2008 Amended DSM Application 70005-24-TR-08 Chugwater Telephone Company 8/21 /2008 General Rate Case
70000-333-ER-08 Rocky Mountain Power 312312009 General Rate Case/ROR 300 I O-GR-94-08 Ouestar Gas Company 411 12009 General Rate Case/ROR
Page 2 of2
APPENDIX A
CASES IN WHICH BRYCE FREEMAN HAS PRESENTED TESTIMONY BEFORE THE WYOMING PUBLIC SERVICE COMMISSION AS OF 10/13/2016
Docket Number Com~anl'.
20004-75-ER-08 Montana/Dakota Uti lities
300009-48-ER-08 Wyoming Gas Company 20000-342-EA-09 Rocky Mountain Power 20000-352-ER-09 Rocky Mountain Power 20002-75-ER-09 Black Hills Power, Inc.
30022-148-GR- I 0 Source Gas Distribution LLC 20003-108-EA-l 0
Cheyenne Light, Fuel & Power, Inc. 30005-140-EA-I 0 20000-383-EA-l 0 Rocky Mountain Power 20000-384-ER- l 0 Rocky Mountain Power 20000-388-ER-l 0 Rocky Mountain Power 20000-400-ER- I 0 Rocky Mountain Power 20003-114-ER-l I Cheyenne Light, Fuel & Power, Inc. 30005-157-GR- l 1 Cheyenne Light, Fuel & Power, Inc. 20000-ER-405-11 Rocky Mountain Power 20002-81-EA- I 1 Cheyenne Light, Fuel & Power, Inc.
20003-1 13-EA-1 I Black Hills Power 20000-418-EA- I 2 Rocky Mountain Power 300 I 0-123-GA- I 2 Questar Gas Company 80007-33-WP- I 3 Vista West Water Company 30016-72-GP-I 3 Pinedale Natural Gas Company
300 I 0-1 34-GA-l 3 Questar Gas Company 30022-219-GA-l 3 Source Gas Distribution LLC 70000-1601-TA-14 Qwest Corp., dba CenturyLink QC 20000-446-ER- I 4 Rocky Mountain Power 80007-36-WR-l 4 Vista West Water Company 30013-297-GR- I 4 Montana/Dakota Utilities 30016-75-GR-14 Pinedale Natural Gas Company 300 I 0-145-GA-l 5 Questar Natural Gas Company 20002-98-EA- I 5 Cheyenne Light. Fuel & Power Company.
20003-145-EA- I 5 Black Hills No1thwest Wyoming Gas Uti lity 30005-208-GA-l 5 Company, LLc, d/b/a Black Hills Energy and 300 11-92-GA-l 5 Black Hills Power, Inc. 20003-146-ET-15 Cheyenne Light, Fuel & Power Company 20004-117-ER-16 Montana/Dakota Utilities
PBR =PERFORMANCE BASED RA TE MAKING AFOR =ALTERNATIVE FORM OF REGULATION CPCN = Certificate of Public Convenience and Necessity RB=Rate Base RR=Revenue Requirement RD=Rate Design
Subject
Hearing Of Date Testimonl'.
417/2009 General Rate Case/ROR
5118/2009 General Rate Case/ROR 9/ 1/2009 Avoided Costs
4/16/2010 ROR 5110/20 I 0 ROR 7/19/2010 Energy Efficiency/Decoupling
1/27/2011 DSM
5/ 11 /2011 DSM 6/20/2011 General Rate Case/ROR 8/1 /2011 A voided Costs
3/19/2012 CPCN 6/ 18/2012 General Rate Case/ROR - Electric 6/ 18/2012 General Rate Case/ROR - Gas 7/2/2012 General Rate Case/ROR/Prudence
7131 /2012 CPCN
3/26/2013 CPCN 4/ 1112013 Wexpro II Agreement 8/ 19/2013 Pass-On/Commodity Cost 1/29/2014 Pass-On/Commodity Cost 1/27/2014 Wexpro II Agreement 3/26/2014 CPCN 9/16/2014 Competitive Designation I 0/13/2014 General Rate Case/ROR/Prudence 1/28/2015 General Rate Case/RR/COS/Rate Design 5/ 19/2015 ROR 6/30/2015 ROR/RB/RR/RD/Other Issues 11 / 1/2015 Wexpro II Agreement
5/2/2016 Cost of Service Gas
6/1 //2016 Tariff Filing 1/18/2017 ROR
- -
Company
Name Ameren Corporation Avista Corporation Black Hills Corporation CMS Energy Corporation NorthWestern Corporation PG&E Corporation Public Service Enterprise Group SCANA Corporation SEMPRA Energy American Electric Power Co. Edison International El Paso Electric Company IDACORP, Inc. PNM Resources, Inc. Portland General Electric Company
Average Median Minimum Maximum
Ticker
Symbol
&
Exchange NYSE-AEE NYSE-AVA NYSE-BKH NYSE-CMS NYSE-NEW NYSE-PCG NYSE-PEG NYSE-SCG NYSE-SRE NYSE-AEP NYSE-EIX NYSE-EE NYSE-IDA NYSE-PNM NYSE-POR
- -
%Of
Debt 49.5% 50.0% 48.0% 65.5% 50.5% 48.5% 44.0% 56.0% 58.0% 49.0% 45.0% 57.5% 47.0% 52.5% 47.5%
51.23% 49.50% 44.00% 65.50%
- -
%Of
Preferred 0.5% 0.0% 0.0% 0.0% 0.0% 0.5% 0.0% 0.0% 0.0% 0.0% 7.0% 0.0% 0.0% 1.0% 0.0%
0.60% 0.00% 0.00% 7.00%
- -
%Of
Common 50.0% 50.0% 52.0% 34.5% 49.5% 51.0% 56.0% 44.0% 42.0% 51.0% 48.0% 42.5% 53.0% 46.5% 52.5%
48.17% 50.00% 34.50% 56.00%
- -
Category Comb Comb Comb Comb Comb Comb Comb Comb Comb
Electric Electric Electric Electric Electric Electric
- -
Regulated
Electric
Revenue 85%
66% 78% 81%
58% 36% 82% 100% 100% 100% 100% 100%
82.15% 83.47% 36.00%
100.00%
- -
Regulated
Gas
Revenue 15%
30% 22% 19%
19% 39% 0% 0% 0% 0% 0% 0%
11.98% 7.53% 0.00%
39.00%
OCA Exhibit 201.1 Page 1 of 5
- -
Company
Name Ameren Corporation Avista Corporation Black Hills Corporation CMS Energy Corporation NorthWestern Corporation PG&E Corporation Public Service Enterprise Group SCANA Corporation SEMPRA Energy American Electric Power Co. Edison International El Paso Electric Company IDACORP, Inc. PNM Resources, Inc. Portland General Electric Company
Average Median Minimum Maximum
--
Regulated
Revenue 100% 98% 94% 95% 100% 100% 64% 77% 75% 82%
100% 100% 100% 100% 100%
92.40% 100.00% 64.00%
100.00%
--- - -
Bond Rating
S&P Moody's BBB+ Baal BBB Baal BBB Baal
BBB+ Baa2 BBB A3
BBB+ A3 BBB+ Baa2 BBB+ Baa3 BBB+ Baal BBB Baal
BBB+ A3 BBB Baal BBB Baal
BBB+ Baa3 BBB A3
-Value Line Projected
2017
Dividends
Per Share $1.78 $1.42 $1.84 $1.32 $2.08 $2.08 $1.72 $2.42 $3.28 $2.39 $2.10 $1.29 $2.24 $0.96 $1.34
$1.88 $1.84 $0.96 $3.28
- -Common
Stock
Price
9/1/2016 $49.15 $40.52 $58.41 $41.85 $57.77 $61.81 $42.59 $70.01
$103.70 $64.41 $72.70 $45.23 $75.81 $31.56 $42.03
$57.17 $57.77 $31.56
$103.70
- -
Calculated
Dividend
Yield 3.62% 3.50% 3.15% 3.15% 3.60% 3.37% 4.04% 3.46% 3.16% 3.71% 2.89% 2.85% 2.95% 3.04% 3.19%
3.31% 3.19% 2.85% 4.04%
- ,
Floataiton
Adjusted
Dividend
Yield 3.75% 3.62% 3.26% 3.26% 3.72% 3.48% 4.18% 3.57% 3.27% 3.84% 2.99% 2.95% 3.06% 3.15% 3.30%
3.43% 3.30% 2.95% 4.18%
OCA Exhibit 201.1 Page 2 of 5
- -Value Line
Earnings
Growth
Rate 6.0% 5.0% 7.5% 6.0% 6.5%
12.0% 3.0% 4.5% 8.0% 4.0% 3.5% 2.5% 3.0% 9.0% 5.5%
5.73% 5.50% 2.50%
12.00%
---Value Line
Dividends
Growth
Rate 4.0% 4.0% 6.0% 6.5% 5.5% 7.0% 5.0% 5.0% 7.0% 5.0% 9.0% 5.0% 7.5%
10.0% 6.0%
6.17% 6.00% 4.00%
10.00%
- -
Company
Name Ameren Corporation Avista Corporation Black Hills Corporation CMS Energy Corporation NorthWestern Corporation PG&E Corporation Public Service Enterprise Group SCANA Corporation SEMPRA Energy American Electric Power Co. Edison International El Paso Electric Company IDACORP, Inc. PNM Resources, Inc. Portland General Electric Company
Average Median Minimum Maximum
-Value Line
Book Value
Growth
Rate 3.5% 3.5% 5.0% 6.0% 4.5% 4.5% 5.0% 5.0% 3.0% 4.0% 5.5% 3.5% 4.0% 3.5% 4.0%
4.30% 4.00% 3.00% 6.00%
- -
Yahoo
Growth
Rate 5.20% 5.00% 7.90% 7.27% 5.00% 5.70% 0.94% 5.40% 6.78% 3.81% 2.07% 7.00% 4.00% 9.00% 6.30%
5.42% 5.40% 0.94% 9.00%
- ,
Zachs
Growth
Rate 6.10% 5.00% 6.50% 6.60% 5.00% 4.40% 2.40% 5.30% 6.90% 4.90% 5.30% 4.40% 4.00% 7.60% 6.20%
5.37% 5.30% 2.40% 7.60%
- -
Earnings Per Share
$3.25 $2.50 $4.25 $2.50 $4.00 $4.50 $3.50 $4.75 $7.50 $4.25 $5.00 $2.50 $4.50 $2.35 $2.75
- - - -
Value Line
Projected '17 to '19 Dividends Per Share
$2.05 $1.60 $2.20 $1.60 $2.32 $2.70 $2.00 $2.80 $4.00 $2.75 $2.60 $1.50 $2.70 $1.30 $1.60
Retention Ratio
36.92% 36.00% 48.24% 36.00% 42 .00% 40.00% 42.86% 41.05% 46.67% 35.29% 48.00% 40.00% 40.00% 44.68% 41.82%
41.30% 41.05% 35.29% 48.24%
- ,
Value Line ROE
9.50% 8.50% 10.50% 13.50% 10.00% 10.50% 10.50% 10.00% 13.50% 9.50% 10.50% 8.50% 9.00% 9.50% 9.00%
10.17% 10.00% 8.50% 13.50%
OCA Exhibit 201.1 Page 3 of 5
- ,
Sustainable
Growth Rate 3.51% 3.06% 5.06% 4.86% 4.20% 4.20% 4.50% 4.11% 6.30% 3.35% 5.04% 3.40% 3.60% 4.24% 3.76%
4.21% 4.20% 3.06% 6.30%
..
Historic Nominal
GDP
Growth Rate 3.10% 3.10% 3.10% 3.10% 3.10% 3.10% 3.10% 3.10% 3.10% 3.10% 3.10% 3.10% 3.10% 3.10% 3.10%
(A)
Company
Name Ameren Corporation Avista Corporation Black Hills Corporation CMS Energy Corporation NorthWestern Corporation PG&E Corporation Public Service Enterprise Group SCANA Corporation SEMPRA Energ-y American Electric Power Co. Edison International El Paso Electric Company IDACORP, Inc. PNM Resources, Inc. Portland General Electric Company
Average Median Minimum Maximum
(AA)
Projected Nominal
GDP
Growth Rate 4.00% 4.00% 4.00% 4.00% 4.00% 4.00% 4.00% 4.00% 4.00% 4.00% 4.00% 4.00% 4.00% 4.00% 4.00%
(AB)
Value Line
Beta 0.75 0.75 0.90 0.70 0.70 0.65 0.70 0.70 0.80 0.70 0.70 0.70 0.75 0.80 0.75
0.74 0.70 0.65 0.90
(AC)
Value Line
Annual Total
Return 6.0% 5.5% 6.5% 6.0% 6.0% 6.5% 7.0% 6.0% 7.5% 6.0% 7.0% 5.5% 6.0% 6.0% 6.0%
6.23% 6.00% 5.50% 7.50%
(AD)
Value Line Current
Yield 3.5% 3.2% 2.8% 3.0% 3.3% 3.1% 3.8% 3.3% 2.8% 3.5% 2.6% 2.7% 2.7% 2.6% 3.0%
3.06% 3.00% 2.60% 3.80%
(AE)
Discounted
Cash Flow With
Sustainable Growth
7.3% 6.7% 8.3% 8.1% 7.9% 7.7% 8.7% 7.7% 9.6% 7.2% 8.0% 6.3% 6.7% 7.4% 7.1%
7.64% 7.68% 6.35% 9.57%
(AF)
Discounted
Cash Flow With
Analysts' Growth 9.51% 8.62% 10.56% 9.89% 9.22%
10.85% 6.29% 8.64% 10.50% 8.07% 6.61% 7.58% 6.72% 11.68% 9.30%
8.94% 9.22% 6.29% 11.68%
OCA Exhibit 201.1 Page 4 of 5
(AG)
Discounted
Cash Flow With Historic Nominal GDP
Growth 6.85% 6.72% 6.36% 6.36% 6.82% 6.58% 7.28% 6.67% 6.37% 6.94% 6.09% 6.05% 6.16% 6.25% 6.40%
6.53% 6.40% 6.05% 7.28%
(A) (AH)
Discounted Cash Flow
With Company Projected
Nominal GDP Name Growth
Ameren Corporation 7.75% Avista Corporation 7.62% Black Hills Corporation 7.26% CMS Energy Corporation 7.26% NorthWestern Corporation 7.72% PG&E Corporation 7.48% Public Service Enterprise Group 8.18% SCANA Corporation 7.57% SEMPRA Energy 7.27% American Electric Power Co. 7.84% Edison International 6.99% El Paso Electric Company 6.95% IDACORP, Inc. 7.06% PNM Resources, Inc. 7.15% Portland General Electric Company 7.30%
Average 7.43% Median 7.30% Minimum 6.95% Maximum 8.18%
(AI)
Long Term
Risk Free
Rate 2.279% 2.279% 2.279% 2.279% 2.279% 2.279% 2.279% 2.279% 2.279% 2.279% 2.279% 2.279% 2.279% 2.279% 2.279%
(AJ)
Long Term
Equity Risk
Premium 7.00% 7.00% 7.00% 7.00% 7.00% 7.00% 7.00% 7.00% 7.00% 7.00% 7.00% 7.00% 7.00% 7.00% 7.00%
(AK)
Long Term
CAPM 7.53% 7.53% 8.58% 7.18% 7.18% 6.83% 7.18% 7.18% 7.88% 7.18% 7.18% 7.18% 7.53% 7.88% 7.53%
7.44% 7.18% 6.83% 8.58%
OCA Exhibit 201. l Page 5 of 5
' ,
Company Name
Ameren Corporation Avista Corporation Black Hills Corporation CMS Energy Corporation NorthWestern Corporation PG&E Corporation Public Service Enterprise Group SCANA Corporation SEMPRA Energy American Electric Power Co. Edison International El Paso Electric Company IDACORP, Inc. PNM Resources, Inc. Portland General Electric Com pa
Average Median Minimum Maximum
NCDCF With Short Term Analysts' Growth/Long Term CBO GDP Growth
' , ' ,
Ticker
Symbol
& Bond Rating Exchange S&P Moody's
NYSE-A EE BBB+ Baal NYSE-AVA BBB Baal NYSE-BKH BBB Baal NYSE-CMS BBB+ Baa2 NYSE-NEW BBB A3 NYSE-PCG BBB+ A3 NYSE-PEG BBB+ Baa2 NYSE-SCG BBB+ Baa3 NYSE-SRE BBB+ Baal NYSE-AEP BBB Baal NYSE-EJX BBB+ A3 NYSE-EE BBB Baal NYSE-IDA BBB Baal NYSE-PNM BBB+ Baa3 NYSE-POR BBB A3
' , ' ,
Value Line Earnings Yahoo
Growth Growth Rate Rate 6.0% 5.20% 5.0% 5.00% 7.5% 7.90% 6.0% 7.27% 6.5% 5.00%
12.0% 5.70% 3.0% 0.94% 4.5% 5.40% 8.0% 6.78% 4.0% 3.81% 3.5% 2.07% 2.5% 7.00% 3.0% 4.00% 9.0% 9.00% 5.5% 6.30%
' ,
Zachs
Growth Rate
6.10% 5.00% 6.50% 6.60% 5.00% 4.40% 2.40% 5.30% 6.90% 4.90% 5.30% 4.40% 4.00% 7.60% 6.20%
5 Year Analysts'
Growth Rate
5.77% 5.00% 7.30% 6.62% 5.50% 7.37% 2.11% 5.07% 7.23% 4.24% 3.62% 4.63% 3.67% 8.53% 6.00%
5.51% 5.50% 2.11% 8.53%
OCA Exhibit 201.2 Page I of 2
' , '
Constant Dividends
Growth Per Share Rate 2017
4.00% $1.78 4 .00% $1.42 4.00% $1.84 4.00% $1.32 4.00% $2.08 4.00% $2.08 4.00% $1.72 4.00% $2.42 4 .00% $3.28 4.00% $2.39 4.00% $2.10 4 .00% $1.29 4.00% $2.24 4.00% $0.96 4.00% $1.34
' ,
Company Name
Ameren Corporation Avista Corporation Black Hills Corporation CMS Energy Corporation NorthWestern Corporation PG&E Corporation Public Service Enterprise Group SCANA Corporation SEMPRA Energy American Electric Power Co. Edison International El Paso Electric Company IDACORP, Inc. PNM Resources, Inc. Portland General Electric Compa
Average Median Minimum Maximum
NCDCF With Short Term Analysts' Growth/Long Term CBO GDP Growth
' , ' ,
Current
Stock Price 9/1/2016 2018 2019 2020 2021 2022 IRR ($49.15) $1 .88 $1.99 $2.11 $2.23 $2.36 8.06% ($40.52) $1 .49 $1.57 $1 .64 $1 .73 $1.81 7.79% ($58.41) $1.97 $2.12 $2.27 $2.44 $2.62 7.77% ($41.85) $1.41 $1.50 $1 .60 $1 .71 $1 .82 7.66% ($57.77) $2.19 $2.32 $2.44 $2.58 $2.72 7.99% ($61.81) $2.23 $2.40 $2.57 $2.76 $2.97 8.05% ($42.59) $1 .76 $1 .79 $1 .83 $1.87 $1 .91 7.84% ($70.01) $2.54 $2.67 $2.81 $2.95 $3.10 7.75%
($103.70) $3.52 $3.77 $4.04 $4.34 $4.65 7.78% ($64.41) $2.49 $2.60 $2.71 $2.82 $2.94 7.88% ($72.70) $2.18 $2.25 $2.34 $2.42 $2.51 6.90% ($45.23) $1.35 $1.41 $1.48 $1 .55 $1 .62 7.01% ($75.81) $2.32 $2.41 $2.50 $2.59 $2.68 6.98% ($31.56) $1.04 $1.13 $1 .23 $1 .33 $1.45 7.84% ($42.03) $1 .42 $1.51 $1.60 $1.69 $1.79 7.60%
7.66% 7.78% 6.90% 8.06%
OCA Exhibit 201.2 Page 2of2
' ,
Company Name
Ameren Corporation Avista Corporation Black Hills Corporation CMS Energy Corporation NorthWestern Corporation PG&E Corporation Public Service Enterprise Group SCANA Corporation SEMPRA Energy American Electric Power Co. Edison International El Paso Electric Company IDACORP, Inc. PNM Resources, Inc. Portland General Electric Com pa
NCDCF With Short Term Analysts' Growth/Long Term Historic GDP Growth
' , ' , ' , ' , ,
Ticker Value Line 5 Year Symbol Earnings Yahoo Zachs Analysts'
& Bond Rating Growth Growth Growth Growth Exchange S&P Moody's Rate Rate Rate Rate
NYSE-AEE BBB+ Baal 6.0% 5.20% 6.10% 5.77% NYSE-AVA BBB Baal 5.0% 5.00% 5.00% 5 .00% NYSE-BKH BBB Baal 7.5% 7.90% 6.50% 7.30% NYSE-CMS BBB+ Baa2 6.0% 7.27% 6.60% 6 .62% NYSE-NEW BBB A3 6.5% 5.00% 5.00% 5 .50% NYSE-PCG BBB+ A3 12.0% 5.70% 4.40% 7 .37% NYSE-PEG BBB+ Baa2 3.0% 0.94% 2.40% 2 .11% NYSE-SCG BBB+ Baa3 4.5% 5.40% 5.30% 5.07% NYSE-SRE BBB+ Baal 8.0% 6.78% 6.90% 7.23% NYSE-AEP BBB Baal 4.0% 3.81% 4.90% 4.24% NYSE-EIX BBB+ A3 3.5% 2.07% 5.30% 3 .62% NYSE-EE BBB Baal 2.5% 7.00% 4.40% 4 .63% NYSE-IDA BBB Baal 3.0% 4.00% 4.00% 3.67% NYSE-PNM BBB+ Baa3 9.0% 9.00% 7.60% 8 .53% NYSE-POR BBB A3 5.5% 6.30% 6.20% 6 .00%
' ,
Constant
Growth Rate
3.10% 3 .10% 3.10% 3.10% 3.10% 3.10% 3.10% 3.10% 3.10% 3.10% 3.10% 3.10% 3.10% 3.10% 3.10%
OCA 201.3 Page 1 of2
Dividends Per Share
2017 $1.78 $1.42 $1.84 $1.32 $2.08 $2.08 $1.72 $2 .42 $3.28 $2.39 $2 .10 $1.29 $2 .24 $0.96 $1.34
-
Company Name
Ameren Corporation Avista Corporation Black Hills Corporation CMS Energy Corporation NorthWestern Corporation PG&E Corporation Public Service Enterprise Group SCANA Corporation SEMPRA Energy American Electric Power Co. Edison International El Paso Electric Company IDACORP, Inc. PNM Resources, Inc. Portland General Electric Compa
NCDCF With Short Term Analysts' Growth/Long Term Historic GDP Growth
- - - -
Current
Stock Price 9/1/2016 2018 2019 2020 2021 2022 IRR ($49.15) $1.88 $1.99 $2.11 $2.23 $2.36 7.29% ($40.52) $1.49 $1.57 $1.64 $1 .73 $1 .81 7.02% ($58.41) $1.97 $2.12 $2.27 $2.44 $2.62 7.00% ($41.85) $1.41 $1.50 $1 .60 $1.71 $1.82 6.89% ($57.77) $2.19 $2.32 $2.44 $2.58 $2.72 7.22% ($61.81) $2.23 $2.40 $2.57 $2.76 $2.97 7.28% ($42.59) $1.76 $1.79 $1.83 $1.87 $1 .91 7.07% ($70.01) $2 .54 $2.67 $2.81 $2.95 $3.10 6.98%
($103.70) $3.52 $3.77 $4.04 $4.34 $4.65 7.00% ($64.41) $2.49 $2.60 $2.71 $2.82 $2.94 7.11% ($72.70) $2 .18 $2.25 $2.34 $2.42 $2.51 6.11% ($45.23) $1.35 $1.41 $1.48 $1.55 $1 .62 6.22% ($75.81) $2.32 $2.41 $2.50 $2.59 $2.68 6.19% ($31.56) $1 .04 $1 .13 $1.23 $1 .33 $1.45 7.07% ($42.03) $1.42 $1.51 $1 .60 $1 .69 $1 .79 6.82%
OCA 201.3 Page 2of2
' ,
Company Name
Ameren Corporation Avista Corporation Black Hills Corporation CMS Energy Corporation NorthWestern Corporation PG&E Corporation Public Service Enterprise Group SCANA Corporation SEMPRA Energy American Electric Power Co. Edison International El Paso Electric Company IDACORP, Inc. PNM Resources, Inc. Portland General Electric Com pa
NCDCF - Short Term Analysts' Growth/Long Term Sustainable Growth
' , , ' , ' ,
Ticker Value Line 5 Year Symbol Earnings Yahoo Zachs Analysts'
& Bond Rating Growth Growth Growth Growth Exchange S&P Moody's Rate Rate Rate Rate
NYSE-A EE BBB+ Baal 6.0% 5.20% 6.10% 5.77% NYSE-AVA BBB Baal 5.0% 5.00% 5.00% 5.00% NYSE-BKH BBB Baal 7.5% 7.90% 6.50% 7.30% NYSE-CMS BBB+ Baa2 6.0% 7.27% 6.60% 6.62% NYSE-NEW BBB A3 6.5% 5.00% 5.00% 5.50% NYSE-PCG BBB+ A3 12.0% 5.70% 4.40% 7.37% NYSE-PEG BBB+ Baa2 3.0% 0.94% 2.40% 2.11% NYSE-SCG BBB+ Baa3 4.5% 5.40% 5.30% 5.07% NYSE-SRE BBB+ Baal 8.0% 6.78% 6.90% 7.23% NYSE-AEP BBB Baal 4.0% 3.81% 4.90% 4.24% NYSE-EIX BBB+ A3 3.5% 2.07% 5.30% 3.62% NYSE-EE BBB Baal 2.5% 7.00% 4.40% 4.63% NYSE-IDA BBB Baal 3.0% 4.00% 4.00% 3.67% NYSE-PNM BBB+ Baa3 9.0% 9.00% 7.60% 8.53% NYSE-POR BBB A3 5.5% 6.30% 6.20% 6.00%
Constant
Growth Rate 3.51% 3.06% 5.06% 4.86% 4.20% 4.209/o 4.50% 4.11% 6.30% 3.35% 5.04% 3.40% 3.60% 4.24% 3.76%
OCA 201.4 Page 1 of 2
Dividends Per Share
2017 $1.78 $1.42 $1.84 $1.32 $2.08 $2.08 $1.72 $2.42 $3.28 $2.39 $2.10 $1.29 $2.24 $0.96 $1.34
,
Company Name
Ameren Corporation Avista Corporation Black Hills Corporation CMS Energy Corporation NorthWestern Corporation PG&E Corporation Public Service Enterprise Group SCANA Corporation SEMPRA Energy American Electric Power Co. Edison International El Paso Electric Company IDACORP, Inc. PNM Resources, Inc. Portland General Electric Com pa
NCDCF - Short Term Analysts' Growth/Long Term Sustainable Growth
' , ' , ' ,
Current
Stock Price 9/1/2016 2018 2019 2020 2021 2022 IRR ($49.15) $1.88 $1 .99 $2.11 $2.23 $2.36 7.64% [$40.52) $1 .49 $1.57 $1.64 $1 .73 $1.81 6.98% [$58.41) $1.97 $2.12 $2.27 $2.44 $2.62 8.69% ($41.85) $1.41 $1 .50 $1 .60 $1 .71 $1 .82 8.41% [$57.77) $2.19 $2.32 $2.44 $2.58 $2.72 8.16% [$61.81) $2.23 $2.40 $2.57 $2.76 $2.97 8.22% ($42.59) $1 .76 $1.79 $1 .83 $1 .87 $1 .91 8.27% [$70.01) $2.54 $2.67 $2.81 $2.95 $3.10 7.84%
[$103.70) $3.52 $3.77 $4.04 $4.34 $4.65 9.77% ($64.41) $2.49 $2.60 $2.71 $2.82 $2.94 7.33% [$72.70) $2.18 $2.25 $2.34 $2.42 $2.51 7.83% [$45.23) $1 .35 $1.41 $1.48 $1 .55 $1.62 6.48% ($75.81) $2.32 $2.41 $2.50 $2.59 $2.68 6.63% [$31.56) $1 .04 $1 .13 $1 .23 $1 .33 $1.45 8.06% [$42.03) $1.42 $1.51 $1 .60 $1 .69 $1 .79 7.40%
OCA 201.4 Page 2of2
(A)
Company
Name
Ameren Corporation Avista Corporation
Black Hills Corporation CMS Energy Corporation NorthWestern Corporation
PG&E Corporation Public Service Enterprise Group
SCANA Corporation SEMPRA Energy
American Electric Power Co. Edison International El Paso Electric Company
IDACORP, Inc. PNM Resources, Inc. Portland General Electric Company
Average Median Minimum Maximum
(B)
Ticker
Symbol
&
Exchange
NYSE-A EE
NYSE-AVA NYSE-BKH
NYSE-CMS NYSE-NEW NYSE-PCG
NYSE-PEG NYSE-SCG NYSE-SRE NYSE-AEP NYSE-EIX
NYSE-EE NYSE-IDA NYSE-PNM
NYSE-POR
(C)
%Of
Debt
49.5% 50.0% 48.0% 65.5% 50.5% 48.5% 44.0% 56.0% 58.0% 49.0% 45.0% 57.5% 47.0% 52.5% 47.5%
51.2% 49.5% 44.0% 65.5%
Quarterly DCF Analysis
(D)
%Of
Preferred
0.5% 0.0% 0.0% 0.0% 0.0% 0.5% 0.0% 0.0% 0.0% 0.0% 7.0% 0.0% 0.0% 1.0% 0.0%
0.6% 0.0% 0.0% 7.0%
(E)
%Of
Common
50.0% 50.0% 52.0% 34.5% 49.5% 51.0% 56.0% 44.0% 42.0% 51.0% 48.0% 42.5% 53.0% 46.5% 52.5%
48.2% 50.0% 34.5% 56.0%
(F)
Category
Comb Comb
Comb Comb Comb Comb
Comb Comb Comb
Electric
Electric Electric Electric Electric
Electric
(G)
Regulated
Electric
Revenue
85%
66% 78% 81%
58% 36% 82%
100% 100% 100% 100% 100%
82% 83% 36%
100%
(H)
Regulated
Gas
Revenue
15%
30% 22% 19%
19% 39% 0% 0% 0% 0% 0% 0%
12% 8% 0%
39%
OCA Exhibit 201.5 Page I of 5
(A)
Company
Name Ameren Corporation Avista Corporation Black Hills Corporation CMS Energy Corporation NorthWestern Corporation PG&E Corporation Public Service Enterprise Group SCANA Corporation SEMPRA Energy American Electric Power Co. Edison International El Paso Electric Company IDACORP, Inc. PNM Resources, Inc. Portland General Electric Company
Average Median Minimum Maximum
(I)
Regulated
Revenue 100% 98% 94% 95% 100% 100% 64% 77% 75% 82% 100% 100% 100% 100% 100%
92% 100% 64%
100%
Quarterly DCF Analysis
CJ) (K)
Bond Rating
S&P Moody's BBB+ Baal BBB Baal BBB Baal
BBB+ Baa2 BBB A3
BBB+ A3 BBB+ Baa2 BBB+ Baa3 BBB+ Baal BBB Baal
BBB+ A3 BBB Baal BBB Baal
BBB+ Baa3 BBB A3
(L)
Value Line
Projected
Annual Dividend
Per Share $1.74 $1.38 $1.71 $1.26 $2.02 $1.98 $1.66 $2.33 $3.08 $2.30 $2.00 $1.25 $2.12 $0.91 $1.28
$1.80 $1.74 $0.91 $3.08
(M)
Value Line
Projected 1st
Quarter Dividend
Per Share $0.44 $0.35 $0.43 $0.32 $0.51 $0.49 $0.42 $0.58 $0.77 $0.58 $0.50 $0.31 $0.53 $0.23 $0.32
(N)
Value Line
Projected 2nd
Quarter Dividend
Per Share $0.44 $0.35 $0.43 $0.32 $0.51 $0.49 $0.42 $0.58 $0.77 $0.58 $0.50 $0.31 $0.53 $0.23 $0.32
OCA Exhibit 201.5 Page 2of 5
(0)
Value Line
Projected 3rd
Quarter Dividend
Per Share $0.44 $0.35 $0.43 $0.32 $0.51 $0.49 $0.42 $0.58 $0.77 $0.58 $0.50 $0.31 $0.53 $0.23 $0.32
(A)
Company
Name Ameren Corporation Avista Corporation Black Hills Corporation CMS Energy Corporation NorthWestern Corporation PG&E Corporation Public Service Enterprise Group SCANA Corporation SEMPRA Energy American Electric Power Co. Edison International El Paso Electric Company IDACORP, Inc. PNM Resources, Inc. Portland General Electric Company
Average Median Minimum Maximum
(P)
Value Line
Projected 4th
Quarter Dividend
Per Share $0.44 $0.35 $0.43 $0.32 $0.51 $0.49 $0.42 $0.58 $0.77 $0.58 $0.50 $0.31 $0.53 $0.23 $0.32
Quarterly DCF Analysis
(Q)
Common
Stock
Price
9/1/2016 $49.15 $40.52 $58.41 $41.85 $57.77 $61.81 $42.59 $70.01
$103.70 $64.41 $72.70 $45.23 $75.81 $31.56 $42.03
$57.17 $57.77 $31.56
$103.70
( R)
Calculated
Dividend
Yield 3.54% 3.42% 2.93% 3.02% 3.50% 3.20% 3.90% 3.33% 2.97% 3.57% 2.75% 2.76% 2.79% 2.87% 3.05%
3.17% 3.05% 2.75% 3.90%
(S)
Floataiton
Adjusted
Dividend
Yield 3.66% 3.53% 3.03% 3.12% 3.62% 3.31 o/o 4.04% 3.44% 3.07% 3.69% 2.84% 2.85% 2.89% 2.97% 3.15%
3.28% 3.15% 2.84% 4.04%
(T)
Value Line
Earnings
Growth
Rate 6.0% 4.5% 5.0% 6.5% 2.0% 1.5%
10.5% 5.0% 4.0% 5.5% 6.5% 5.0% 6.5% 6.5% 6.5%
5.43% 5.50% 1.50%
10.50%
(U)
Value Line
Dividends
Growth
Rate 4.5% 2.0% 8.0% 6.0% 2.0% 2.5% 4.0% 3.0% 2.5% 5.0% 2.5% 3.0% 6.0% 6.0% 6.0%
4.20% 4.00% 2.00% 8.00%
(V)
Value Line
Book Value
Growth
Rate 4.0% 1.5% 2.5% 6.0% 3.5% 4.0% 4.5% 5.5% 2.0% 4.5% 4.0% 5.0% 7.0% 7.0% 7 .0%
4.53% 4.50% 1.50% 7.00%
OCA Exhibit 20 I .5 Page 3of 5
(W)
Yahoo
Growth
Rate 4.90% 8.90% 3.49% 6.64% 2.36% 0.34%
10.40% 5.35% 6.43% 4.46% 4.00% 5.00% 4.40% 4.40% 4.40%
5.03% 4.46% 0.34%
10.40%
(A)
Company
Name Ameren Corporation Avista Corporation Black Hills Corporation CMS Energy Corporation NorthWestern Corporation PG&E Corporation Public Service Enterprise Group SCANA Corporation SEMPRA Energy American Electric Power Co. Edison International El Paso Electric Company IDACORP, Inc. PNM Resources, Inc. Portland General Electric Company
Average Median Minimum Maximum
(X)
Zachs
Growth
Rate 4.90% 8.40% 4.80% 6.10% 3.00% 3.00% 5.50% 4.90% 6.50% 4.20% 4.00% 5.00% 4.80% 4.80% 4.80%
4.98% 4.80% 3.00% 8.40%
(Y)
Earnings Per Share
$4.10 $3.00 $1.75 $2.25 $4.25 $6.75 $2.40 $4.25 $1.40 $2.50 $3.30 $2.25 $1.75 $1.75 $1.75
Quarterly DCF Analysis
(Z) (AA)
Value Line
Projected '17 to '19 Dividends Per Share
$2.80 $1.80 $1.30 $1.35 $2.75 $3.80 $1.20 $2.35 $1.00 $1.45 $2.10 $1.43 $0.95 $0.95 $0.95
Retention Ratio
31.71% 40.00% 25.71% 40.00% 35.29% 43.70% 50.00% 44.71% 28.57% 42.00% 36.36% 36.44% 45.71% 45.71% 45.71%
39.44% 40.00% 25.71% 50.00%
(AB)
Value Line ROE
12.00% 9.50% 15.00% 13.50% 9.00%
10.50% 12.50% 10.00% 11.50% 10.00% 9.50%
11.50% 19.00% 19.00% 19.00%
12.77% 11.50% 9.00%
19.00%
(AC)
Sustainable
Growth Rate 3.80% 3.80% 3.86% 5.40% 3.18% 4.59% 6.25% 4.47% 3.29% 4.20% 3.45% 4.19% 8.69% 8.69% 8.69%
5.10% 4.20% 3.18% 8.69%
(AD)
Historic Nominal
GDP
Growth Rate 3.10% 3.10% 3.10% 3.10% 3.10% 3.10% 3.10% 3.10% 3.10% 3.10% 3.10% 3.10% 3.10% 3.10% 3.10%
OCA Exhibit 201 .5 Page 4of 5
(AE)
Projected Nominal
GDP
Growth Rate 4.30% 4.30% 4.30% 4.30% 4.30% 4.30% 4.30% 4.30% 4.30% 4.30% 4.30% 4.30% 4.30% 4.30% 4.30%
(AF)
Value Line
Beta 0.80 0.75 0.75 0.70 0.60 0.70 0.85 0.75 0.85 0.70 0.70 0.80 0.80 0.80 0.80
0.76 0.75 0.60 0.85
(A)
Company
Name Ameren Corporation Avista Corporation Black Hills Corporation CMS Energy Corporation NorthWestern Corporation PG&E Corporation Public Service Enterprise Group SCANA Corporation SEMPRA Energy American Electric Power Co. Edison International El Paso Electric Company IDACORP, Inc. PNM Resources, Inc. Portland General Electric Company
Average Median Minimum Maximum
(AG)
Value Line
Annual Total
Return 7.0% 6.5% 8.0% 6.5% 5.5% 6.0% 6.5% 6.0% 6.5% 6.0% 6.5% 8.0%
10.5% 10.5% 10.5%
7.37% 6.50% 5.50%
10.50%
(AH)
Value Line Current
Yield 3.2% 3.8% 4.4% 3.4% 4.1 o/o 4.0% 2.5% 3.8% 4.5% 3.9% 4.0% 3.4% 3.2% 3.2% 3.2%
3.64% 3.80% 2.50% 4.50%
Quarterly DCF Analysis
(AI)
Quarterly
Discounted
Cash Flow With
Analysts' Growth 9.08%
10.97% 7.57% 9.67% 6.18% 5.01%
13.06% 8.66% 8.84% 8.56% 7.78% 7.96% 8.23% 8.32% 8.51%
8.56% 8.51% 5.01%
13.06%
(AJ)
Quarterly
Discounted
Cash Flow With
Sustainable Growth 7.60% 7.46% 6.99% 8.64% 6.91% 8.02% 10.47% 8.04% 6.45% 8.03% 6.39% 7.14%
11.72% 11.81% 12.00%
8.51% 8.02% 6.39%
12.00%
(AK)
Quarterly
Discounted
Cash Flow With Historic Nominal GDP
Growth 6.88% 6.75% 6.22% 6.32% 6.83% 6.51 o/o 7.28% 6.65% 6.27% 6.91% 6.03% 6.04% 6.08% 6.16% 6.35%
6.49% 6.35% 6.03% 7.28%
(AL)
Quarterly
Discounted Cash Flow
With Projected
Nominal GDP Growth 8.10% 7.96% 7.44% 7.53% 8.05% 7.73% 8.49% 7.87% 7.48% 8.13% 7.24% 7.25% 7.29% 7.37% 7.56%
7.70% 7.56% 7.24% 8.49%
OCA Exhibit 201.5 Page 5of 5